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THE CIR.CUIT FLOW OF MONEY 


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MONEY 


BY 

WILLIAM TRUFANT FOSTER 

AND 

WADDILL CATCHINGS 




BOSTON AND NEW YORK 

HOUGHTON MIFFLIN COMPANY 
tEfje &ibers;foe iPress Cambridge 


1923 


MG' & a / 

•F7 


COPYRIGHT, 1923, BY THE POLLAK FOUNDATION FOR ECONOMIC RESEARCH 

ALL RIGHTS RESERVED 



tEfje Ptoersilie press 

CAMBRIDGE . MASSACHUSETTS 
PRINTED IN THE U.S.A. 


M -6 1923 

©C1A7 04 836 


L 



PREFACE 


The Poliak Foundation for Economic Research welcomed 
the opportunity to publish, as its first volume, Professor 
Irving Fisher’s The Making of Index Numbers, because 
the first need of the science of economics appears to 
be accurate and generally accepted instruments of meas • 
urement. In this second volume, we venture upon a pre¬ 
liminary discussion of money, because money, which is 
our best measure of the strength of economic motives, 
should be made the core of economic theory, and because 
more of the world’s difficulties are due to monetary policies 
than to any other economic cause. In any event, this is a 
good time to study the subject. It seems likely that the 
era of monetary chaos through which we are passing will 
become the classic example of unsound public finance. 

An understanding of the part that money plays in the 
world is prerequisite to a solution of the most critical 
problems of our day, national and international. Such an 
understanding requires a knowledge of those attributes of 
a money economy that make it essentially different from 
a barter economy. Failure to take this difference fully 
into account appears to be at the root of various popular 
fallacies. Even our textbooks insist, as a rule, that '‘all 
trade is, of course, barter,” and that “the young econo¬ 
mist must do exactly as Solomon and Hiram did — think 
in goods.” With attention fixed on goods rather than on 
money, however, the economist, young or old, is in danger 
of overlooking those aspects of modern production and 
distribution, particularly the unbalancing of supply and 
demand, that have most to do with the periodic ups and 
downs of business. 


VI 


PREFACE 


Indeed, it is obvious facts and indisputable conclusions 
that are most frequently overlooked. For that reason, we 
have not hesitated to deal at length with various proposi¬ 
tions that we are well aware will be regarded by some read¬ 
ers as tiresome platitudes. That the world can consume, 
in the long run, no more than it produces; that stand¬ 
ards of living depend on sustained production; that pro¬ 
duction cannot be sustained at a high level without a 
medium of exchange; that gold is the most satisfactory 
basis for a medium of exchange; that central banks should 
be free from political pressure; that monetary reforms are 
impossible as long as governments meet their deficits by 
printing money; that sharp fluctuations in price-levels 
lead to disastrous results; that competition among con¬ 
sumers rather than governments should control prices and 
production: these are among the commonplaces of sound 
thinking that the war-wracked world of to-day disregards 
to its sorrow. 

“The money fallacy,” said Simon Newcomb, many 
years ago, “is periodic, overwhelming us, not at regular 
intervals, but from time to time, owing to the influence of 
changing events. The Americans, more than any other 
people, have been its victims.” And now, as a natural 
aftermath of a world war, we are beset on every hand with 
proposals for reforming the entire economic order. Most 
of them blithely ignore what money does, and just as 
blithely assume that money does, or can be made to do, 
what it cannot possibly do. To offer another panacea for 
social ills is no part of our purpose. This is fair warning. 
The reader who is bold enough to venture beyond this 
preface into the discussion of a subject that has long been 
regarded as one of the dullest parts of ‘ ‘ the dismal science ’ ’ 
will do well to heed this warning. Otherwise, after read¬ 
ing all that the volume offers, he may cry impatiently: 


PREFACE 


Vll 

“Well, if all this is true of a money economy, have you 
nothing more to offer by way of constructive proposals?” 
In subsequent studies, based in part upon this volume, the 
Poliak Foundation expects to have something to say in 
answer to that question. It hopes thereby to be of some 
help, at least, to the various economic agencies, happily 
increasing in number, that are now endeavoring, on the 
safe basis of fact and reason rather than on the hopeless 
basis of prejudice and passion, to hasten the day when 
money — with its purchasing power protected against 
excessive fluctuations — will do more to promote and less 
to hinder the work of the world. 

The following pages, however, are only introductory — 
an indispensable groundwork, we believe, but nothing 
more. It goes without saying that a discussion of all as¬ 
pects of the topics we have touched upon — the rate of 
interest, the function of price, the circuit velocity of 
money, to go no further — would take us far beyond the 
confines of this volume. Here we have dealt only with 
some of the larger aspects of monetary phenomena, the 
significance of which appears to be overlooked at times in 
discussions of business problems and reform programs. 
Later on, we may discuss certain refinements and quali¬ 
fications. 

For the present, we shall be content if the reader agrees 
with us that all proposals for changes in the established 
order, no matter from what source they arise, must be 
discussed in the light of the characteristics here outlined 
of an industrial society based upon the exchange of goods 
and services for money. This much is fundamental. In so 
far as our exposition is erroneous, it must be corrected; 
but in so far as it is sound, it must be accepted as the ad¬ 
mitted matter upon which constructive programs will 
have to be based. If all reformers proceeded from such 


PREFACE 


• • • 
viu 

safe ground — if they were wise enough to distinguish 
what they know from what they do not know, and to 
insist on knowing how things really are, and why they are 
as they are, before launching a campaign for changing 
them — the world would be spared much strife and false 
accusation and bitterness and wasted effort. 

The authors are grateful to all those who have read 
parts of the manuscript. Especially helpful have been the 
frequent criticisms by Hudson B. Hastings of the Poliak 
Foundation, and the suggestions offered, from time to 
time, by Irving Fisher, Wesley C. Mitchell, Gilbert H. 
Montague, Malcolm C. Rorty, John E. Rovensky, Martin 
J. Shugrue, Carl Snyder, O. M. W. Sprague, and Paul M. 
Warburg. Particular acknowledgment should be made of 
the indispensable services of Edith McDonald of the 
Poliak Foundation. Some of the chapters are in part re¬ 
printed, with the kind permission of the publishers, from 
papers that appeared during 1922 in the Atlantic Monthly , 
the American Economic Review, the Annalist , and The 
Saturday Evening Post. 

As footnotes, “ like little dogs barking at the text,” 
annoy many readers, we have corralled all the little dogs 
in the Appendix, where they can be found easily enough 
by any one who wants them. 

William Trufant Foster 
Waddill Catchings 

Newton, Massachusetts 
January 1, 1923 


CONTENTS 


I. Money a Central Interest of Life i 

II. Money and Other Terms defined 15 

III. Money as a Medium of Exchange 32 

IV. Money as a Standard of Value 41 

V. Money and Inflation 53 

VI. Money and the Gold Basis 77 

VII. Money and the Commodity Basis 97 

VIII. Money and the Rate of Interest 126 

IX. Money and International Trade 137 

X. Money and the Price-Level 154 

XI. Money and Prices 185 

XII. Money as Suspended Purchasing Power 212 

XIII. Money in Relation to Goods 228 

XIV. Money and Speculation 242 

XV. Money in Production 250 

XVI. Money advanced in Production 269 

XVII. Money in Consumption 277 

XVIII. The Circuit Flow of Money 298 

XIX. The Annual Production-Consumption 

Equation 321 

XX. Costs and Profits in Relation to the 

Annual Equation 332 

XXI. Conclusions 351 

Appendix : Notes to All Chapters 369 

Index 4°3 




LIST OF FIGURES 


1. Fluctuations in Business Activity, 1877-1922 2 

2. Currency in Circulation in the United States, 

with Trend of Population, 1800-1920 23 

3. The Value of the Gold Dollar Measured in 

Goods at Wholesale 44 

4. Wholesale Prices in Relation to Stock of Mone¬ 

tary Gold, 1914-1921 45 

5. Prices of Basic Commodities and Cost of Living, 

1916-1921 ' hi 

6. Production and Population (Coal Production 

and Crop Production), 1880-1920 113 

7. Depreciation of European Currencies, Septem¬ 

ber, 1922 145 

8. Retail Food Prices and Bank Loans, 1913-1921 182 

9. Individual Prices — Dispersing from 1913-1918 206 

10. Individual Quantities — Dispersing from 1913- 

1918 207 

11. Commodity Prices in Relation to Production, 

1900-1920 230 

12. Loans of all Reporting Banks compared with 

Street Loans, 1919-1921 243 

13. Sales at Retail compared with Sales at Whole¬ 

sale, 1919-1921 295 

14. Turnover of Bank Deposits and Shares Sold on 

the New York Stock Exchange, 1919-1921 302 

15. The Circuit Flow of Money 305 








MONEY 


, CHAPTER 1 

MONEY A CENTRAL INTEREST OF LIFE 

Periodically, our economic system becomes the spec¬ 
tacle of unemployed men who are able and eager to work; 
abundant tools to work with and materials to work upon; 
and a nation in need of the goods that these men, by the 
use of these idle machines, might make out of these sur¬ 
plus materials. Yet, month after month, the men and 
machines and materials are not brought into productive 
relations with each other. In the United States, for ex¬ 
ample, during the year 1921, there were millions of men, 
women, and children in need of food, clothing, shelter, 
and innumerable other products of labor. At the same 
time there were vast stocks of unsold, finished goods 
awaiting consumption, warehouses crowded with raw 
materials, factories and machines ready to do their part 
in production, larger possibilities of currency and bank 
credit expansion than ever before, and several millions of 
idle men and women who were eager to go to work. Yet 
there was sustained business depression. The economic 
organization of society had again fallen short of fully serv¬ 
ing its one great purpose — the production and distribu¬ 
tion of goods. 

Great Losses are due to Periodic Business Depressions 

The extent of the economic loss due to these recurrent 
depressions can be seen at a glance. In Figure 1, the line 


2 


MONEY 


between the dark area and the light area indicates fluctu¬ 
ations in the state of business activity in the United States 
from 1877 to 1922. 1 The light area represents roughly the 
volume of production and employment: the dark area 
represents roughly the volume of unemployment and con¬ 
sequent loss in production. If the entire period had been 
as prosperous as its best years, the entire area would be 
white. In other words, if business had been sustained at 
the level which it has actually reached from time to time, 
the economic loss represented by the dark area would 
have been avoided. 


FLUCTUATION IN BUSINESS ACTIVITY 



The magnitude of that loss may be comprehended even 
more readily by means of a few comparisons. The loss is 
greater than the combined national incomes of Canada 
and Japan. It exceeds the total expenditures for educa¬ 
tion in the United States. It is far greater than the annual 
income of all our millionaires. If the total income of this 
group had been distributed among the wage-earners, 
and even if this had not caused a further falling-off in 
production, such a distribution of national income would 
not have made up for the loss to wage-earners due to in¬ 
dustrial depressions. Indeed, the 250,000 persons in the 

1 All the footnotes will be found, chapter by chapter, in the Appendix. 
























































































































MONEY A CENTRAL INTEREST OF LIFE 3 

United States who have the largest incomes — and this 
includes all those who have annual incomes of over ten 
thousand dollars — do not receive an amount equal to 
the loss shown in the dark area — a loss due to our fail¬ 
ure to keep business going at the rate which we have 
already demonstrated is a human possibility, with hu¬ 
man beings as they are. 

To “the man in the street,” this whole situation is 
bewildering; and nearly every one in our day is a “man 
in the street,” as far as economics is concerned. Even the 
ablest of our leaders in business and in finance and the 
most competent of our professional economists offer only 
partial and tentative analyses of these recurrent periods 
of depression and consequent suffering. None of the ex¬ 
planations are entirely convincing, and the best of them 
are unsatisfactory even to their authors. 

Now, since ours is a money economy, and since it is 
therefore almost exclusively through the use of money 
that productive relationships are maintained, as far as 
they are maintained at all, among men, machines, and 
materials, the question naturally arises to what extent the 
characteristics of money are responsible for industrial 
depressions. In the United States, at least, other expla¬ 
nations do not carry us very far. In many countries, there 
are economic difficulties due to density of population, 
lack of natural resources, devastated areas, loss of man 
power, unstable government, adverse climatic conditions, 
widespread illiteracy, and unprogressive methods of pro¬ 
duction and distribution. To none of these causes can we 
ascribe the plight of our own country in 1921. We had 
plenty of resources, human and material: we seemed to 
lack only the means of using them — placing the men 
where they could go on with the world’s work, moving the 
raw products to factories, the finished products to dealers, 


4 


MONEY 


and thence to people who wanted to use them. Had not 
something happened to our medium of exchange? At 
least the question seems worth studying. 

Human Interests tend to gravitate around Money 

For better or for worse, we live in a pecuniary society. 
Money has come to be as necessary in the exchange of 
goods as language in the exchange of ideas. We might 
carry the analogy further: so difficult is it to make words 
serve the purpose of conveying thought, that it sometimes 
seems as if the function of language were to obscure 
thought; and so difficult is it to make dollars serve their 
purpose of carrying on trade, that people have wondered 
at times whether the function of money were not to ob¬ 
struct trade. The economic world of to-day, however, 
could not exist without money. Nothing approaching the 
present world production would be possible without divi¬ 
sion of labor, and nothing approaching the present di¬ 
vision of labor would be possible without a medium of 
exchange. “Without trustworthy money,” says H. G. 
Wells, “Europe is as paralyzed as a brain without whole¬ 
some blood. She cannot act. She cannot move. Employ¬ 
ment becomes impossible and production dies away. Our 
civilization is, materially, a cash and credit system, de¬ 
pendent on men’s confidence in the value of money.” 

The effects of mistaken monetary policies are passed on 
from generation to generation. “It may be doubted,” 
says Macaulay, “whether all the misery which had been 
inflicted on the nation in a quarter of a century, by bad 
kings, bad parliaments, and bad judges, was equal to the 
misery caused in a single year by bad crowns and bad 
shillings.” The Government of France, during the French 
Revolution, with its deluge of inconvertible assignats , did 
more harm to industry in a single year than stupid and 


MONEY A CENTRAL INTEREST OF LIFE 


5 


irresponsible monarchs had done in a century. “Com¬ 
merce was dead — betting took its place.” And in our 
own generation the Bolshevist destruction of the cur¬ 
rency appears to have caused more suffering than all the 
tyranny of the Czars of Russia. It is, in fact, almost ex¬ 
clusively through the medium of money that various 
causes operate to injure or promote the economic well¬ 
being of society. 

Our modern economic life is founded on money. Our 
whole industrial order is based on production of goods for 
sale at a money profit. The economic value of virtually 
everything, except consumers’ goods already in the hands 
of consumers, is based on the expectation that it can be 
sold for money, or will have a part in producing some¬ 
thing that can be sold for money. In our warehouses, 
factories, shops, and stock-yards are vast stores of 
wealth — apples and amethysts, beets and barrels, car¬ 
riages and cattle, and so on to the end of a list that, in 
its detail of grades, sizes, and styles, would outrun the 
pages of the biggest dictionary; and in all these multi¬ 
farious things the owners have one common, dominant 
interest, namely, to exchange them as soon as possible 
for the largest possible amount of money. Services as 
well as commodities compete in price markets; human 
success is measured mainly by salaries and wages; in¬ 
dividual initiative is rewarded mainly in terms of money. 

Now and then, to be sure, we read in newspapers about 
a minister who declines to accept a larger salary, a con¬ 
tractor who does public work without desire for profit, or 
a young idealist who scorns a legacy of a million dollars; 
but these cases appear in the headlines because they are 
news. A great editor once said to his reporters: “ If a dog 
bites a man, that is nothing; but if a man bites a dog, that 
is news.” When money is not a dominating influence in 


6 


MONEY 


everyday affairs, that is news. Health, knowledge, seren¬ 
ity, honor, reputation, love — these are exalted joys in 
life, no doubt, that cannot be bought: and yet it is 
probable that no one is fully aware of the subtle and far- 
reaching pecuniary influences that have their part even 
in those life interests that are often thought of as without 
money and without price. More and more intensely, more 
and more generally, and over a wider and wider area, men 
and women are concerned with the problem of exchang¬ 
ing their products or their services for as much money as 
possible, or with the .equally engrossing and insistent 
problem of obtaining as much satisfaction as possible for 
the money they have to spend. In short, human interests, 
ambitions, and activities tend to gravitate around money. 2 

This was not the economic order of the remote past, and 
it may not be the economic order of the distant future. 
It may or may not be the best conceivable basis upon 
which to produce, exchange, and consume goods; but since 
it is largely the result of human characteristics that have 
been taking root since prehistoric times, we are not likely 
to make much progress unless we take due account of 
these deep-rooted fundamentals of the present order. It 
seems certain, therefore, that no one can solve our eco¬ 
nomic riddles who does not understand the economic 
meaning of money. It seems equally certain that mis¬ 
understanding of the function of money — what it can 
do for us and what it cannot do, what can be and what 
cannot be charged to its account — will lead to futile 
projects for social reform, political blunders, misdirected 
condemnation, discouragement, ill-will — in short, worse 
than wasted human efforts. 

Such seem to be the recurrent attempts to cure our in¬ 
dustrial ills by increasing the supply of money without 
increasing the supply of goods; by basing our currency 



MONEY A CENTRAL INTEREST OF LIFE 


7 


on labor-hours or on energy units rather than on gold; by 
fixing prices and interest rates through government fiat 
rather than through competition; by promoting a thrift 
campaign and a buyers’ week at the same time; and by 
seeking to increase our exports, but refusing to take 
anything but gold in return — projects to be considered 
presently. As a result of the notion that monetary prob¬ 
lems require no serious study, we are certain to have fre¬ 
quent attempts to settle currency questions by popular 
vote. 

The Function of Money is often regarded as Insignificant 

It is too much to expect that a knowledge of the 
characteristics of money will prove an adequate explana¬ 
tion of all that goes on in business. Such a knowledge is, 
however, an indispensable groundwork for any profitable 
discussion of the subject. 

Yet the role that money plays in the world’s work, 
apart from its obvious convenience, has not been ade¬ 
quately dealt with. Most writers have held too literally 
to those passages in the writings of John Stuart Mill 
which seem to belittle the function of money. “Great as 
the difference would be between a country with money 
and a country wholly without it,” said Mill, “it would be 
only one of convenience. . . . There cannot, in short, be 
intrinsically a more insignificant thing in the economy of 
society than money, except in the character of a contri¬ 
vance for sparing time and labor.” 3 For decades this 
idea has been passed along from writer to writer, usually 
without critical consideration, in spite of the fact that, 
since the time of Mill, the development of bank credit has 
given money a far different role in the economy of society. 
The four universally proclaimed uses of money — as a 
medium of exchange, as a measure of value, as a store of 


8 


MONEY v 


value, and as a standard of value — appear to have been 
taken for granted without the rigorous, quantitative 
examination that such important functions deserve. 

Beyond the historic view of this fourfold advantage of 
money, to be found in nearly all treatises on the general 
principles of economics, there has not yet been any ade¬ 
quate discussion of the results of the change from a barter 
economy to a money and credit economy. Most writers 
have been content to follow Mill in assuming that, apart 
from its convenience, money has little to do with the 
world’s work. Even Jevons saw no place for money among 
the fundamentals of economic theory; in his view, money 
belonged to “the higher complications of the subject.” 4 
And the Dean of the School of Commerce, Accounts and 
Finance, of New York University, declares that econo¬ 
mists still “consider the problems of interest, profits, and 
wages, the whole theory of the production, exchange, and 
distribution of wealth, as if money were not used at all, it 
being assumed that the introduction of money as a me¬ 
dium makes no difference in results.” 5 Some modern 
writers follow Mill in stating explicitly that money has 
little further significance. Apparently they think of 
money only as facilitating the production and exchange 
of goods. Usually no account is taken of the ways in 
which money can obstruct business, as well as the ways 
in which money can facilitate business. 

In general treatises, we frequently meet such sentences 
as the following. It goes without saying that there is 
truth in these quotations: it also goes without saying that 
single sentences, apart from the context, do not in every 
case fairly represent the views of the author. Taken as a 
whole, however, these quotations do represent the tradi¬ 
tional emphasis in the treatment of this subject. 

“One of the greatest of all labor-saving devices is 
money.” 6 


MONEY A CENTRAL INTEREST OF LIFE 


9 


1 ‘Money . . . serves as the general instrument of ex¬ 
change, as a measure and medium in the sale and pur¬ 
chase of other commodities, and as a common denomina¬ 
tor in comparing values.” 7 

“ Money is simply one kind of wealth which is taken, 
not for itself, but to pass along.” 8 

“ Credit is a means to the end of larger production and 
is therefore itself productive.” 9 

'‘Money is a tool which easily enables persons to ex¬ 
change their services or their products.” 10 

“Aristotle says that ‘as the machinery [of barter] for 
bringing in what was wanted, and of sending out a sur¬ 
plus, was inconvenient, the use of money was devised as 
a matter of necessity. . . . ’ The few and simple words 
with which Aristotle has treated this subject cannot be 
bettered.” 11 

“A means by which capital can be given mobility and 
thence greater efficiency.” 12 

“Money is merely a great convenience in the process of 
making exchanges.” 13 

“The credit system facilitates exchange.” 14 

“Money is in reality nothing more than a medium for 
exchanging one kind of goods for another kind, and, after 
all, the fundamental form of exchange is barter. . . . Re¬ 
course has long ago been had to a process of complex bar¬ 
ter. . . . The final outcome is, however, nothing more than 
the exchange of goods for goods.” 15 

■ Such statements, repeated over and over again, and 
reiterated even in the present era of bank credit, divert 
attention from what may well prove to be a fruitful field 
of economic inquiry. They make money appear, on the 
contrary, as a matter of mere convenience — always a 


10 


MONEY 


convenience — rather easily understood, and not par¬ 
ticularly worthy of study. If a money economy has 
important characteristics, other than those mentioned 
above, which do not pertain to a system of barter, few 
would suspect it from reading scores of books which pur¬ 
port to cover the principles of economics. An examina¬ 
tion of twenty-five books, reserved in a university library 
for students in the general course in economics, fails to 
reveal any hint that money may obstruct the production 
and exchange of goods — any hint that there afe un¬ 
solved monetary problems of the first magnitude. 

Objections are raised, moreover, to any tendency to¬ 
ward making money the central theme of economic the¬ 
ory. Leading articles in recent numbers of the American 
Economic Review , the journal of the American Economic 
Association, are devoted to belittling the function of 
“ price economists.” Dr. Wesley Clair Mitchell’s idea 
that money should be the center of economic study, that 
it clarifies, simplifies, and makes the study more realistic, 
more useful, and more profound, “is rejected,” says Dr. 
Frank A. Fetter, “by nearly every one who examines 
it.” 16 For men to make money the center of economic 
studies and, at the same time, to be concerned primarily 
with human welfare, seems to many writers impossible. 

Knowledge of Money is a Groundwork for the Study of 
Business 

Nevertheless, our difficulty in accounting adequately 
for what is going on in industry, and what is failing to go 
on, calls insistently for more extensive and exacting stud¬ 
ies of money than have yet been made. Surely the study 
of social welfare would lead to more dependable programs 
of reform, if it were based on a more accurate knowledge 
than we now possess of actual economic processes. ‘ * While 


MONEY A CENTRAL INTEREST OF LIFE u 


the understanding of these processes,” as Dr. Mitchell 
rightly says, “has been the chief aim of economic investi¬ 
gation for a century, no one fancies that this fundamental 
task has yet been adequately performed. In the interests 
of social welfare itself, we need clearer insight into the in¬ 
dustrial process of making goods, the business process 
of making money, and the way in which both sets of ac¬ 
tivities are related to each other and to the individual’s 
inner life. Into our conjoint attack upon these problems, 
a clearer recognition of the role played by money promises 
to bring more definite order and more effective coopera¬ 
tion. It helps us to formulate our tasks in ways that 
suggest definite things to try next.” 17 Professor Alfred 
Marshall, of Cambridge University, goes further still: 
he expresses doubt whether there can be any science of 
economics at all without money, or public honors meted 
out by graduated tables, or some other measure of the 
strength of motives that would prove to be as conven¬ 
ient and exact as money . 18 Pareto expressed similar views. 
Evidently, we cannot appraise the part played by money 
in the world’s work until we have more definite knowledge 
of the exact ways in which money creates or makes pos¬ 
sible our modern economic achievements and difficulties. 

But we cannot reach this distant goal until we have first 
taken fully into account the characteristics of money. A 
study of this subject — which is the central theme of the 
following chapters — is prerequisite to an understanding 
of the ups and downs of business, and, indeed, of economic 
and social problems generally. Incidentally, we shall find 
that the change from barter to money, far from being a 
mere matter of convenience, has been fraught with such 
far-reaching consequences that some of the traditional 
economic principles, based as they usually have been 
upon a world of barter trading, do not apply to the cur- 


12 


' MONEY 


rency and credit trading world of to-day. John Stuart 
Mill declared that money “ obscures, to an unpracticed 
apprehension, the true character of industrial enterprise.” 
And Basil Brackett, of the British Treasury, reports King 
Solomon as saying in an imaginary conversation that 
thinking in terms of money is the root of most of our evils. 
Undoubtedly there is wisdom in this remark — consid¬ 
ering the cloudy character of our thinking. But the way 
to clarity is not through ignoring money and focusing 
attention upon goods, as we are often adjured to do. 
On the contrary, the assumption that money is merely a 
matter of convenience, of only superficial significance, 
appears to have obscured the true character of commer¬ 
cial operations, delayed our discovery of the ways in 
which the economic order is periodically deranged, and 
in general impeded the progress of economic science. 
After we have examined some of the consequences of the 
change from barter, the question may seem pertinent 
whether there can be intrinsically a more significant thing 
in the economy of society than money. 

At least we shall then be in a better position to consider 
the conclusion of R. G. Hawtrey that “the trade cycle is 
a purely monetary phenomenon.” 19 Indeed, it seems 
probable that if we knew enough about the characteris¬ 
tics of money and took all these characteristics duly into 
account, we should see many other contemporary prob¬ 
lems in an entirely new light. What would be the effect 
on business in the United States, for example, of the can¬ 
cellation of our foreign debts? What would be the effect, 
on the other hand, if these debts were paid in gold? What, 
if paid in goods? Under what circumstances is the pay¬ 
ment of dividends by corporations good for business as a 
whole? What is the effect upon business of the policies of 
corporations with respect to undivided profits? Exactly 



MONEY A CENTRAL INTEREST OF LIFE 13 

what kinds of thrift are good for business and under what 
circumstances? To what extent, if any, can workers as a 
body increase their real wages by forcing increased money 
wages? By what means can the products of industry 
be more equitably distributed? Do present methods of 
financing business lead inevitably to crises? There is no 
discussion of money that is sufficiently comprehensive 
and accurate to serve as a basis for answers to such 
questions as these. 

Nevertheless, we may yet find answers, for there is no 
inherent reason why we should not understand the rela¬ 
tion of money to business. Money and its operations are 
not occult or mysterious. The materials with which we 
have to deal are nearly all in plain sight: on the one hand, 
the pieces of metal and paper which constitute our money; 
and, on the other hand, the sacks of meal, rubber tires, 
phonographs, and so forth which money somehow either 
helps or hinders us to make and to move into the hands of 
consumers. On both sides, we are concerned with tangible 
things, the counting and tabulating of which are difficult, 
to be sure, but not impossible. We are not dealing with 
the stuff that dreams are made of; nor are we baffled by 
hidden and wholly unknown factors, as we are in the 
search for the cause of cancer. The physical aspects of 
money and goods, it is true, are not the only factors of our 
problem: we must also take into account mental attitudes 
toward money and toward goods. But even these difficul¬ 
ties do not seem insuperable: our task has more to do 
with applying to monetary problems what we already 
know about mental processes than with discovering a 
new body of psychological truth; in any event, more to 
do with objective behavior in business transactions — 
behavior which can be studied as a mass phenomenon 
recorded by statistics — than with subjective mental 


H 


MONEY 


processes. This is one of the problems in connection with 
which economists have more to contribute to psychology 
than to borrow from it. “The elementary principles of 
the subject,” as Jevons said half a century ago, “are not 
of a complex character: and if we hold tenaciously to these 
principles, we may perhaps be saved from that dangerous 
kind of intellectual vertigo which often attacks writers on 
the currency.” 


CHAPTER II 

N 

MONEY AND OTHER TERMS DEFINED 

At the outset, we shall do well to define the terms with 
which our discussion is mainly concerned. Many contro¬ 
versies are futile because neither side knows exactly what 
the other side is talking about. This seems particularly 
true of monetary questions. “No subject in political 
economy,” says Dean Johnson, “is to-day more fruitful 
of controversy and misunderstanding among economists, 
and none seems more cloudy and confused in the popular 
mind.” 1 Some of the controversies between “welfare 
economists” and “price economists” are perhaps cases in 
point. At times, disputants think they are in accord on 
principles, merely because their disagreement is hidden 
under ambiguous language. At other times, they think 
they disagree fundamentally concerning ideas, merely 
because they are confused concerning the meaning of 
words. Disputes which seem interminable are sometimes 
ended abruptly and happily upon the accidental discov¬ 
ery that the disputants agreed all the time as to the ques¬ 
tions really at issue. Careful definition of terms helps to 
make such discoveries prompt rather than belated, scien¬ 
tific rather than accidental. 

Political economy, or economics, as we prefer to call 
this branch of social science, stands in special need of 
these precautions because it has only a meager, technical 
terminology that is peculiarly its own. Exactly what do 
we mean by consumption, demand, credit, money, wealth, 
price-levels, profits? These are familiar words of everyday 
speech: nobody hesitates to use any one of them for fear 
that he may not have a clear and accurate idea of its mean- 


i6 


MONEY 


ing. Terms that are equally familiar to the engineering 
profession, such as the moment of inertia and the radius 
of gyration, most of us do not attempt to use at all. We 
know that we do not know what they mean. Various 
other professions have a similar advantage over econom¬ 
ics; their terminology makes it evident that hard study 
is prerequisite to any sensible discussion of their problems. 
Most people do not talk glibly about torts or spectrum 
analyses. About money, however, many people take it for 
granted that they know all they need to know, since their 
daily dealings are in terms of money. For this reason 
they are in special danger of concluding that whatever 
they do not agree with on this subject is wrong and what¬ 
ever they do not understand is nonsense. 2 Economics 
might fare better if it had a forbidding vocabulary of its 
own, freed from the confusion of everyday speech. 

Since it has not, we shall devote this chapter to an expo¬ 
sition of the terms that are most commonly used in suc¬ 
ceeding chapters. For our present purposes, we do not ask 
any one to accept these definitions. All we ask is that 
those who- persist beyond these dull preliminaries will 
bear in mind that all these terms are used consistently 
throughout the volume in accordance with these defini¬ 
tions. General agreement in the use of economic terms 
would be a great convenience; but it is not a necessity. In 
order to arrive at sound conclusions, we need nothing but 
true premises and valid reasoning. Logically, therefore, 
it is of no importance how we define money or any other 
term. The essentials are that our definitions shall be clear 
and definite and that our use of terms shall be consistent 
throughout with our definitions. 3 

Economics defined 

Economics, as we shall use the term in connection with 


MONEY AND OTHER TERMS DEFINED 17 

the money economy of to-day, is the science that deals 
with human interests from the standpoint of price. This 
definition covers not only the production and distribution 
of goods and services, but all other human interests, in so 
far as they are measured in terms of money. Although 
this may seem to be too broad a definition, the usual defi¬ 
nitions are much broader. They are too inclusive to mark 
off the field of economics as a science. It has been defined, 
too broadly for our purposes, as “the study of the mate¬ 
rial world and of the activities and mutual relations of man 
so far as all these are the objective conditions to the grati¬ 
fication and to the welfare of men.” This takes us far into 
the extensive domain of sociology. Too inclusive, also, is 
the definition of economics as the science that “deals with 
those activities of man which are devoted toward securing 
a living.” This is broad enough to cover large areas of the 
fields of chemistry and physics. Objectionable, in the 
same way, is the concept of economics as “ a body of prin¬ 
ciples which govern the practice of economy in its broadest 
sense.” The fundamental characteristic of every science 
is a close approximation to exact measurement. Each sci¬ 
ence is known by its point of view and its consequent units 
of measurement. Mechanics measures an engine in terms 
of horse power, and dietetics measures an egg in terms of 
calories; while economics measures both engines and eggs 
in terms of dollars. Without such a measure, there would 
be no science. For this reason, we consider money the 
central and unifying feature of the science of economics. 

Money defined 

By “money” economists usually mean anything that 
is (1) passed from hand to hand throughout a community 
in payment for commodities and services, and (2) regu¬ 
larly taken with the intention of offering it in payment to 


i8 


MONEY 


others, and (3) customarily received without assay or 
other special test of quality or quantity, and (4) received 
without reference to or reliance upon the personal credit 
of the one who offers it. To cover all this, we shall use the 
term “currency.” 

The term “money” we shall use throughout our discus¬ 
sion, in accordance with the everyday practice of business 
men, to cover not only all forms of currency, but bank 
credit as well. By “bank credit” we'mean deposits trans¬ 
ferable by check. It is important to bear in mind, in con¬ 
nection with all that follows, that the term “money” is 
always used as synonymous with “circulating purchas¬ 
ing power,” and always includes both currency and bank 
credit, as defined above. 

Things that serve the Purposes of Money 

From the standpoint of business, money interests us 
chiefly in so far as it aids in producing goods and moving 
them to consumers. Anything at all which performs that 
work has much the same major effects upon industry as 
though we called it money. And so, in connection with all 
the more important aspects of the world’s work, no mat¬ 
ter how we define “money,” we must take into account 
everything that serves the purposes of money. Otherwise, 
we shall be in constant danger of overlooking some of the 
factors that determine prices and production and, in gen¬ 
eral, the state of business activity. Liberty Bond coupons, 
for example, in so far as they serve as currency, must be 
dealt with as though they were money in circulation. We 
can safely ignore them only if, for the purpose at hand, the 
volume of coupons used to transfer goods is small enough 
to be negligible. The same is true of various other media 
of exchange, not included in our definition of money, 
which sometimes serve the purposes of money. 


MONEY AND OTHER TERMS DEFINED 


19 


For this reason, we must take into account another 
kind of credit, namely, that allowed by dealers to their 
customers. This we shall call “book credit.” Book credit 
is the deferring of a payment of money. A man accepts 
book credit when he postpones the payment of a debt that 
is due to-day, and he extends book credit whenever he 
permits any one to postpone a payment that is due to-day. 
Although this kind of credit is less important than bank 
credit, it must, nevertheless, be taken into account in 
connection with any study of business fluctuations. For 
a while, it moves goods without the use of money. The 
failure to make allowance for book credit, as we shall see 
later on, leads frequently to fallacious reasoning concern¬ 
ing the relation between the money and the goods that 
change hands within any given period of time. 

Money in Circulation defined 

Money is in circulation, in our use of the term, as long 
as it is available for expenditure. The unused lending 
power of banks is not money in circulation, for it is not 
available for expenditure: it becomes money only through 
the joint act of a bank and a borrower. The lending power 
of banks is like gold in the mines; it is not money until 
somebody puts it where it can be used as money. All bank 
deposits are money in circulation, no matter what pro¬ 
portion of these deposits are checked out within any 
given period of time; just as all coins in people’s pockets 
are money in circulation, no matter how many of them 
are spent on any given day. In a certain sense, it is true, 
all money is idle except when it is actually being used in 
exchange; but in that sense only one dollar out of several 
thousand is active, and all the rest are idle, in any given 
minute. It is only a matter of convenience which concep¬ 
tion we employ. Either, if used consistently, leads us to 
the same conclusions as the other. 


20 


MONEY 


Money versus Wealth 

In two opposite ways, money has been a source of con¬ 
fusion to economic thought. First, men attached to 
money a kind of importance which it did not possess. They 
regarded money as a kind of national wealth which, like 
any other kind of national wealth, increased in value as 
its quantity increased. Later, after the fallacy of this first 
position had been exposed by economists, money came to 
be regarded by many people as relatively insignificant. 
And then, mainly through the extensive development 
of bank credit, money achieved a far greater significance 
in the economic world than ever before. Thus, at first 
because its importance was overestimated, and later be¬ 
cause its importance was underestimated, money has 
proved to be an historic stumbling-block in the way of an 
understanding of economic processes and results. 

It is important to keep in mind the distinction between 
money and other forms of wealth. From the standpoint 
of an individual, money is regarded as wealth, for it is a 
command over the objects of wealth. The more money 
an individual has, the better off he is, economically. It is 
not true, however, that the more money a nation has, the 
better off it is. The material wealth of a nation is its 
wheat, factories, railroads, mines, forests. From the com¬ 
munal standpoint, money is wealth only in so far as it is 
made of metal, which is wealth as such. This means that, 
for the individual, money is suspended purchasing power, 
a fact that we shall undertake to show is of the utmost 
importance to business. For the nation, however, money 
is suspended purchasing power only in so far as it is made 
of metal which will be accepted outside the country, on a 
barter basis, in exchange for goods. 

This may seem too simple to need emphasis, but, as a 


MONEY AND OTHER TERMS DEFINED 21 


matter of fact, it is not at all easy to rid the mind of the 
idea that an increase of money is necessarily an increase of 
national wealth. If a man has ten dollars in his pocket, 
and his Government has not been playing fast and loose 
with its currency, he rests secure in the thought that 
those dollars mean for him a fairly definite quantity of 
potatoes, shoes, or tobacco, which is certainly real wealth 
to him. Except as noted, however, money is not wealth, 
and it is not even converted into wealth when it is spent 
for goods. It is merely used as a measure of command 
over wealth and a means of exchanging wealth; and the 
one who receives it uses it in the same way as a measure of 
his command over other people’s wealth. Various popular 
fallacies — those, for example, having to do with over¬ 
production, and with the favorable balance of trade — 
are due, as we shall endeavor to show later on, to the con¬ 
fusion of money and wealth. 

After the World War, the illusion of wealth due to in¬ 
flated money continued. By borrowing during the War, 
England added about forty thousand millions of dollars 
to the wealth of the nation — as wealth is tabulated in 
official reports and usually thought of by the people; 
but it added no material wealth. On the contrary, the 
nation as a whole exchanged vast stores of real wealth — 
machines, ships, chemicals and so forth, used up in the 
War — for paper evidences of debt. This paper is noth¬ 
ing but a kind of claim of some people on a part of the 
future production of all the people. No laborer would 
consider a claim on that which does not yet exist, and 
which he, himself, must produce if he is ever to enjoy it, 
as present wealth. Yet national bookkeeping invites the 
people to make precisely that error. Monetary com¬ 
plexities obscure the fact that no system of bookkeeping 
can be devised, either for individuals or for nations, which 


22 MONEY 

can transform future money obligations into present real 
wealth. 

Prices versus Price-Levels 

Throughout our discussion, we must take special pains 
to keep in mind the distinction between individual prices 
and the general price-level. By individual prices, we 
mean the exchange value of any commodity — say a ton 
of coal or a barrel of flour — in terms of dollars. By the 
general price-level, we mean a composite of all prices; 
that is to say, the cost of coal, flour, and everything else 
at one time or place compared with the cost of the same 
things at another time or place. We shall try to make 
clear that the paramount interest of every community in 
the price-level is clear and simple: where the price-level 
happens to be is of minor importance; the major need is 
that it should stay where it is. The interest of the com¬ 
munity in individual prices — that is to say, in the rela¬ 
tion of prices to each other on a given price-level — is not 
so obvious. That is to be the subject of the eleventh 
chapter. 

Currency in the United States 

Currency in the United States consists of gold coin, 
silver dollars, paper money, and convenient amounts of 
so-called subsidiary money — half-dollars, quarters, dimes, 
nickels, and pennies. The increase in the volume of cur¬ 
rency since 1800, compared with the increase in popula¬ 
tion, is shown in Figure 2. 

The volume of gold coin fluctuates in amount with 
the production of gold, and with the export and import 
of gold, for any one owning gold bullion may at any 
time obtain from the United States Government the 
corresponding amount of gold coin, and any one owning 



MONEY AND OTHER TERMS DEFINED 23 

gold coin may obtain the corresponding amount of gold 
bullion. 

The volume of silver dollars sometimes fluctuates with 
changes in the currency laws. In 1922 there were about 
400 million silver dollars, in the Treasury or in circula¬ 
tion, and under the existing law this amount could not be 



more than about 600 million dollars. There is no reason 
to convert silver dollars into bullion, for as bullion the 
silver in a dollar is not worth a dollar. Paper money con¬ 
sists of gold and silver certificates, United States notes, 
United States Treasury notes, National Bank notes, 
Federal Reserve Bank notes, and Federal Reserve notes. 
Each gold certificate represents a corresponding amount 
of gold in the United States Treasury, and the certificates 
are exchangeable for gold, and gold is exchangeable for 
certificates. Likewise, silver certificates represent actual 
silver dollars in the United States Treasury and are ex- 

















































24 


MONEY 


changeable for these dollars; and silver dollars may be 
exchanged for silver certificates. 

For many years, there have been $346,681,016 of 
United States notes, and under the law this amount re¬ 
mains unchanged. Against these notes there is a gold re¬ 
serve of approximately $150,000,000. When these notes 
are redeemed, they are reissued. United States Treasury 
notes were issued to pay for silver purchased under the 
Act of July 14, 1890. The amount of these notes has been 
reduced by the coinage of silver dollars, until to-day it is 
only approximately $1,500,000. 

National Bank notes may be issued at any time, by any 
National Bank, in any amount not exceeding at any one 
time 125 per cent of the amount of the capital and sur¬ 
plus of the bank. When these notes are issued, the issuing 
bank must deposit, with the Treasurer of the United 
States, United States Government bonds at par, or at 
market price if this is lower, to the full amount of the 
notes issued, and in addition five per cent of the amount 
of the notes in gold to be used in redeeming such of these 
notes as are presented for redemption. 

Federal Reserve Bank notes are issued by Federal Re¬ 
serve Banks under the same condition as National Bank 
notes, except that the amount is not limited by the cap¬ 
ital of the Federal Reserve Banks. Both National Bank 
notes and Federal Reserve Bank notes are obligations of 
the banks and of the United States. 

The paper money of the United States, however, con¬ 
sists largely of Federal Reserve notes. There are approx¬ 
imately 2500 millions of these notes outstanding, while 
there are less than 100 millions of Federal Reserve Bank 
notes and not more than 760 millions of National Bank 
notes. Federal Reserve notes are obligations of the 
United States Government. The conditions under which 


MONEY AND OTHER TERMS DEFINED 


25 


they are used may be discussed to best advantage after a 
short analysis of the Federal Reserve Banking System. 

The Federal Reserve System 

For the purposes of the Federal Reserve System the 
United States has been divided into twelve districts. In 
each district there is a Federal Reserve Bank, situated in 
a large city, and owned mainly by the so-called Member 
Banks. The Member Banks in each district include all 
the National Banks in the district and such of the State 
Banks as have chosen to join the system. Each Federal 
Reserve Bank is directed by a board of governors, partly 
elected by Member Banks of the respective districts, and 
partly appointed by the Federal Reserve Board. All Fed¬ 
eral Reserve Banks are largely under the control of the 
Federal Reserve Board which consists of eight members: 
the Secretary of the Treasury and the Comptroller of the 
Currency, ex ofliciis, and six other members appointed 
by the President of the United States. 

The Federal Reserve Banks receive deposits from Mem¬ 
ber Banks, from the United States Government, from 
such Government agencies as the War Finance Corpora¬ 
tion, and under limited conditions from other banks, but 
not from individuals or corporations. The Federal Re¬ 
serve Banks lend their funds to some extent by purchas¬ 
ing United States Government securities and short-time 
obligations of States, municipalities, and banks; but they 
lend their funds principally by rediscounting for Member 
Banks certain commercial notes, drafts, and bills of ex¬ 
change. These commercial obligations are called “ short- 
time paper,” for they must be in connection with current 
transactions and have not over ninety days to run, except 
in the case of agricultural and live-stock paper which may 
run for six months. Such obligations are called “self- 


26 


MONEY 


liquidating.” This means that the maker of the obliga¬ 
tion is engaged in a transaction where in due course of 
business it is expected that there will be received within 
the time-limit the money to pay the obligation. 

Federal Reserve Notes 

To return now to Federal Reserve notes, a subject of 
much importance in connection with most of the chapters 
that follow. Upon the security of short-time paper, a Fed¬ 
eral Reserve Bank may obtain, from the United States, 
Federal Reserve notes. Behind each of these Federal Re¬ 
serve notes there is not only the short-time obligation of 
some business in good credit which expects the money to 
pay the obligation within the specified time, but also 
the endorsement of a Member Bank, which carries a 
lien on its assets, and the obligation of the Federal Re¬ 
serve Bank. In addition, the Federal Reserve Bank must 
have, in gold reserves, forty per cent of the amount of all 
Federal Reserve notes for which it is responsible, or else 
suffer a penalty. In addition to these reserves against 
notes, a Federal Reserve Bank must maintain a thirty- 
five per cent reserve in gold against its deposits. 

Federal Reserve notes, however, together with all other 
forms of currency, are used for only a small proportion of 
the nation’s business. The rest is effected by means of 
bank credit. We may now consider how bank credit is 
created and used. 

Bank Credit 

Bank credit is based in part but, as we shall note 
presently, only in part, on money entrusted to the bank 
by depositors. Originally a bank of deposit was a custo¬ 
dian of currency and the depositor paid the bank for safe¬ 
guarding it until he demanded it. In the course of time, 


MONEY AND OTHER TERMS DEFINED 27 

experience showed that a bank could be so conducted as 
to pay all depositors on demand (not, of course, the actual 
coins and notes which were deposited but their equiva¬ 
lent) and yet make some use of a considerable portion of 
the money on deposit. This has been possible, however, 
only when banks have made such use of money on de¬ 
posit as never to interfere with the obligation to pay de¬ 
positors on demand. 

In so far as a bank makes use of depositors’ money 
under such conditions that it can regain the money on de¬ 
mand, obviously the bank is prepared to repay its depos¬ 
itors upon their demand. But to make full use of their 
money, banks must part with most of it for definite peri¬ 
ods. Most borrowers from banks require money for ninety 
days, six months, or a year. Although the banks may lend 
depositors money for such fixed periods, the banks re¬ 
main under the obligation to pay depositors on demand. 

Experience has shown that if a bank retains in its 
vaults a part, say fifteen per cent, of the money on de¬ 
posit with it; if it lends part on demand; if it lends part 
for ninety days and part for six months, almost invariably 
the bank is ready to pay those depositors who actually 
demand their money. If money on hand is reduced, 
money loaned on demand can be called in; and then, as 
payments are made to the bank when loans fall due, the 
bank can retain the money, and not lend it out again for 
fixed periods until the bank is assured that the require¬ 
ments of depositors again justify such disposition of their 
money. 

Notwithstanding the fact that a bank need not keep all 
the depositors’ money in its vaults, but may lend it to 
others, the primary duty of a bank is to safeguard this 
money. Depositors are willing that banks should be more 
than mere custodians, but they insist that banks do not 


28 


MONEY 


lose their money. Therefore it is necessary that banks 
not only pay those depositors who demand their money, 
but also safeguard the money of all depositors. Sound 
banking practice involves, therefore, two fundamentals, 
both of which are essential if depositors are to trust their 
money to banks. One is that banks always have at hand 
sufficient money to pay those depositors who demand 
payment. The other is that banks make only such use 
of depositors’ money as is consistent with safeguarding 
this money. 

Depositors continue to have confidence in banks only 
as long as they know that banks are following such a 
policy. If people question the ability of the banks to pay 
depositors on demand and to safeguard all money on 
deposit, money is not deposited with banks. Thus the 
practice of depositing money in banks and the privilege of 
the banks to lend the deposited money rest, first, on the 
sound conduct of banks, and, second, on the depositors’ 
confidence that the banks will continue to be so con¬ 
ducted. Because banks have been so conducted as to 
justify this confidence, depositors no longer pay to have 
their money safeguarded, but on the contrary often 
receive payment from banks for leaving money on de¬ 
posit. It is the fact that banks can safely lend part of the 
money deposits that enables them not only to pay all 
expenses and to render banking service to depositors, but 
also to pay interest on the deposits. 

Bank Deposits are only in Small Part Deposits of Currency 

We have already made note of the fact that checks on 
bank deposits serve much the same purpose as currency, 
and are used in from eighty to ninety per cent of all busi¬ 
ness that involves the use of a medium of exchange. 
Obviously, then, banks must lend much more than the 


MONEY AND OTHER TERMS DEFINED 


29 


currency that is deposited with them. As a matter of 
fact, more than eighty per cent of the total bank deposits 
of the country do not represent currency entrusted to the 
banks by depositors, but arise out of bank loans created 
through the joint acts of banks and borrowers. 

When banks lend money, usually they immediately re¬ 
ceive this money on deposit. Ordinarily, therefore, banks 
lend money by crediting the depositor’s account with the 
money loaned. Sometimes this is described as lending 
money by making “bookkeeping entries.” The fact must 
not be overlooked, however, that such an apparently 
simple bookkeeping transaction involves two of the great 
fundamentals of sound banking: first, in lending the 
money, the bank assumes a risk in connection with the 
loan, for the borrower may not pay the loan; second, in 
receiving the deposit, the bank undertakes to safeguard 
the deposit and to pay the depositor on demand. 

The capital of a bank is one factor of safety to depos¬ 
itors. A bank, as well as any other business enterprise, 
must run risks. No matter how careful bank officers may 
be, some bank loans are not paid in full. The first risk of 
loss, however, is borne by the capital: no depositor loses 
money until all the capital is lost. Thus depositors are 
protected from loss at least to the extent of the bank’s 
capital. 

The relation of the Federal Reserve System to bank 
credit is highly important. In the first place, the legal bank 
reserves are not kept in the vaults of Member Banks, but 
must be deposited with the Federal Reserve Banks. Thus 
bank reserves are combined, and the Federal Reserve 
Bank need keep only thirty-five per cent of these reserves 
in gold as its reserve against deposits. This, however, is 
only the legal minimum: sound banking policy often 
requires more reserves than the legal minimum. In the 


30 


MONEY 


second place, Member Banks of the Federal Reserve 
System are not required to keep more than thirteen per 
cent reserve against demand deposits, which reserve, as 
pointed out above, must in turn be deposited with the 
Federal Reserve Bank. This thirteen per cent reserve is 
adequate only because Member Banks may at any time 
get Federal Reserve notes from the Federal Reserve 
Bank by rediscounting their short-time paper with the 
Federal Reserve Bank. 

Thus we see that the business of the United States is 
carried on partly through the medium of various kinds of 
coins and paper money, but mainly through the medium 
of checks drawn against bank deposits/ 

Goods and Services 

As economics is concerned largely with the production 
and exchange of goods, we shall make frequent use of the 
term “goods.” By goods, we mean not only tangible 
goods, such as cotton and engines, for which we use the 
term “commodities,” but also intangible goods, such as 
light and power, and services, such as the work of teach¬ 
ers, bankers, and motormen. 

The Forces of Supply and Demand 

It has been remarked that you have only to teach a 
parrot to say “supply and demand,” and you have made 
an orthodox economist. Certainly few economic terms 
are as commonly used, as vaguely understood, or as im¬ 
portant. The so-called “laws of supply and demand” 
have proved a prolific source of fallacies. 

“Supply” is used throughout this volume to denote 
the quantity of commodities or services offered for ex¬ 
change at a given time and place, and at a given price. 
“Demand” indicates effective demand; that is to say, 


MONEY AND OTHER TERMS DEFINED 31 

not merely desire, but desire accompanied by money or its 
equivalent: and demand, like supply, always refers to a 
given time, and place, and price. 

In traditional discussions of the subject, we find the 
statement of three fundamental tendencies: 

1. When, at the prevailing price, demand exceeds 
supply, the price tends to rise, and vice versa. 

2. A rise in price tends, sooner or later, to decrease 
demand and to increase supply, and vice versa. 

3. Price tends toward the level at which demand is 
equal to supply. 

It is to these three tendencies that we shall refer when¬ 
ever we speak of the forces of supply and demand. 

Tendencies they are, not laws. This is the most im¬ 
portant general observation we can make concerning 
them. A complete discussion of the subject would deal 
with various causes which, under various conditions, 
offset these tendencies. It will be observed, further, that 
these three statements refer to all prices, not solely to 
the prices of commodities. This is because, with certain 
qualifications, the three forces apply to prices paid for 
the use of capital, which is what we call the rate of in¬ 
terest; and, in a general way, they apply as well to wages 
and to all other remuneration for services. 


, CHAPTER III 

MONEY AS A MEDIUM OF EXCHANGE 

Without a medium of exchange, the economic world of 
to-day would have been impossible. There is at least this 
one fact in monetary history, concerning which there is no 
disagreement. “The degree of specialization which char¬ 
acterizes modern industry,’’ says Henry Clay, “could 
never have been reached under a system of barter. It is 
too minute, too complicated, too extensive both in time 
and space.” 1 The substitution of money payments for 
labor dues, says H. R. Seager, “probably did more than 
anything else to break down the medieval, and usher in 
the modern, system of industry.” 2 E. R. A. Seligman 
concludes that money is “the foundation upon which 
modern economic life rests.” 3 Indeed, there is not much 
to add to the generally accepted views concerning the part 
that money, on account of its convenience , has played in 
facilitating the division of labor, the exchange of goods, 
the collection of taxes, and, consequently, the growth of 
nations — that is to say, in making possible the extremely 
complicated economic world of to-day. 4 

Economic Welfare requires a Medium of Exchange 

Among those who admit all this, however, are many 
who see nothing to admire in the achievement. They feel 
as the outraged Dr. Johnson felt when called upon to 
praise the rendition, by a young pianist, of a composition 
said to be exceedingly difficult. “ Difficult? ” he exclaimed, 
“Difficult? Would to God it were impossible!” And 
some of those who to-day contemplate the periodical 


MONEY AS A MEDIUM OF EXCHANGE 33 

breakdown of our vast, complicated economic machinery, 
and the resultant suffering of those who would gladly 
labor but can find no work, wish that the whole elaborate 
and difficult achievement had been impossible. They 
would gladly overthrow it. And seeing that money is, in 
fact, its foundation, they believe in going to the bottom 
of the matter and utterly destroying money. 

Lenin, who has had the most dramatic opportunity in 
all history for putting this belief into practice, is said to 
have remarked that the surest way to overthrow the 
entire economic system is to destroy its currency. Results 
in Russia seem to show that Lenin is not far from right. 
But they show much more. They show that, while the 
demoralization of the medium of exchange prevents large- 
scale industrial operations and the growth of vast indi¬ 
vidual fortunes, it also prevents a high per capita produc¬ 
tion of wealth without which a high standard of living for 
all the people is impossible. Indeed, to many millions the 
destruction of all currency would inevitably mean death 
by starvation. Consequently, even Bolshevistic Russia 
has felt the necessity, in the interests of the people, of try¬ 
ing to establish a metallic currency which looks very 
much like the currency of the hated Czars. The world, no 
doubt, would be saved from further ill-fated attempts to 
build a better industrial order on the ruins of money, if 
the truth could be broadcast that it is not autocracy, or 
capitalism, or the unequal distribution of wealth that re¬ 
quires a medium of exchange, but the growth of nations 
and the general economic well-being of humanity. 

The Growth of Nations depends on a Medium of Exchange 

A little thought will show that national life, as we 
know it, and the powerful government that it presup¬ 
poses, came into being — and could come into being — 


34 


MONEY 


only after it was possible to use a medium of exchange in 
the collection of taxes. “The system of barter,” says R. H. 
Patterson, “which includes contributions to the State 
of man service, usually military service, and which had 
sufficed for the forays and rude conflicts of limited scope 
which prevailed during the Dark Ages, was wholly inade¬ 
quate for the organized warfare and expeditions of disci¬ 
plined and well-equipped troops, by which national or 
kingly ambition gradually brought Europe to a territorial 
settlement and comparatively stable equilibrium of na¬ 
tional power.” 5 In short, the organization of the admin¬ 
istrative functions of a State never has gone far, and it is 
difficult to conceive how it could go far, supported only 
by payments in kind. 

Consider, for example, merely the personal income taxes 
collected in the United States for the calendar year 1918 
— with no thought for the moment of all other Federal 
revenues and all other Government uses of a circulating 
medium. How could the Treasury Department have col¬ 
lected in goods and services the value represented by 
$1,127,721,835 of taxes from 4,426,114 individuals in 
fifty-one States and territories, and from thousands of 
aliens and citizens residing abroad? Imagine the Federal 
Income Tax Office in Boston, for example, collecting, 
from two hundred thousand Massachusetts taxpayers, 
taxes of $80,000,000 in the form of goods and services — 
short stories, strawberries, scrap iron, silk stockings, 
legal opinions, caskets, cut flowers, theater tickets, hair 
tonic. Imagine the further difficulties and labor of pre¬ 
serving and transporting all these tax payments, in 
exactly the right amounts, and at exactly the right time, 
to meet the unknown and unknowable future wants of 
clerks in Washington, teachers in Alaska, contractors in 
New Orleans, soldiers in the Philippines, and hundreds of 


MONEY AS A MEDIUM OF EXCHANGE 


35 


thousands of others to whom Government payments are 
due. In the primitive tribe where the subject rendered 
tribute to his chief in the form of arrow heads, and in the 
rural New England town where the farmer “ worked out 
his taxes on the road,” payments were easily made in 
what “the State” most needed; but the extension of such 
tax payments beyond the simple tribe or town to a mod¬ 
ern nation involves overwhelming complexities. 

Barter Trading is too Clumsy 

All this is due to the clumsiness of barter. This fact has 
been explained so often that no further emphasis would 
seem necessary, were it not for the evidence in current 
history of a widespread belief that we might somehow 
bring about better human relationships if we could first 
abolish money. The inconveniences of barter — the di¬ 
rect exchange of goods for goods — are illustrated in 
Lieutenant Cameron’s account of his difficulties in buying 
a boat in Africa : “ Syde’s agent wished to be paid in ivory, 
of which I had none; but I found that Mohammed Ibn 
Salib had ivory and wanted cloth. Still, as I had no cloth, 
this did not assist me greatly until I heard that Moham¬ 
med Ibn Gharib had cloth and wanted wire. This I for¬ 
tunately possessed. So I gave Ibn Gharib the requisite 
amount of wire; whereupon he handed over cloth to Ibn 
Salib, who in his turn gave Syde’s agent the wished-for 
ivory. Then he allowed me to have the boat.” 6 This case 
exemplifies the main inconvenience of barter, namely, 
that of finding a man who not only wants what you have 
to sell, but has for sale what you want to buy. 

Among thousands of highly specialized workers in¬ 
cluded in our latest census, we find makers of windmills, 
coffins, lead pipe, calcium lights, and artificial limbs. 
Suppose each of these craftsmen were paid, as laborers 


36 


MONEY 


were once paid, in shares of the products of his own labor. 
Imagine any one of them carrying about a supply of his 
products and trying to use them in his daily round of 
marketing with the butcher, the baker, and the candle¬ 
stick-maker. Without a medium of exchange, a man 
could make shoes and exchange them directly with a man 
who made wheelbarrows, though even in this case the 
indivisibility of the units would cause trouble; but a man 
who made only eyelets could not directly satisfy many of 
his wants on a barter basis. Indeed, in a barter society, 
most of the exchanges that are now easily effected by 
money would be hopelessly cumbersome. The waste in¬ 
volved in finding the double coincidence of wants and in 
exactly balancing accounts, and the very labor involved 
in transporting commodities and in making the exchanges, 
would prevent anything remotely approaching either the 
variety or the volume of present-day trade. 

Textbooks on money have usually pictured the diffi¬ 
culties of the imaginary hatter, in the imaginary days 
before there was any medium of exchange, who wanted to 
buy a house, but who sought in vain for anybody who 
wanted as many hats as the house was worth. To-day the 
difficulty of carrying on internal trade without a medium 
of exchange would be even greater, because most of those 
who wish to buy goods have no goods whatever to offer as 
payment. In the shoe factory, for example, there is a 
bookkeeper, and a sales manager, and a cutter, and a fin¬ 
isher, and a night-watchman; and no one of them pro¬ 
duces anything that he can offer to the butcher in ex¬ 
change for a chop. The butcher does not want their prod¬ 
ucts or their services, any more than he wants the poet’s 
masterpiece. Much less does he desire the admirable 
statement which the accountant has drawn up for the 
furrier across the way. Neither does the accountant want 


MONEY AS A MEDIUM OF EXCHANGE 37 

his pay in furs, nor the jeweler’s office boy his wages in 
wedding rings. The only way to satisfy everybody is by 
means of an interposed something which everybody 
knows that everybody else will accept in exchange for 
whatever goods and services they have to sell. 

Large-Scale Production requires a Medium of Exchange 

In trying to picture the difficulty of collecting taxes on 
our national income without the aid of a medium of ex¬ 
change, we imagined a difficulty that could not have 
arisen; for without a medium of exchange, we could not 
have brought about a division of labor or accumulated 
capital facilities sufficient to produce our present annual 
increment of taxable wealth. Indeed, scarcely any of the 
major economic problems of to-day could have reached 
their present proportions under a barter economy. Even 
John Stuart Mill, who said that there could not be in¬ 
trinsically a more insignificant thing in the economy of 
society than money, except in the character of a contriv¬ 
ance for sparing time and labor, made note of the fact 
that without a circulating medium we should suffer the 
inability to effect any far-reaching division of labor. In¬ 
cidentally, it may be noted as a fact — though this fact 
alone does not prove our point — that there is no in¬ 
stance in history of any considerable industrial develop¬ 
ment without some form of money. 

The vastness of the difficulties of production under a 
barter economy may be seen from concrete examples. If 
any one will try to follow out, in imagination, all the la¬ 
borious transfers of goods from place to place that would 
have been necessary to procure, through direct exchange, 
sufficient materials and services to build the Union Pa¬ 
cific Railroad, he will visualize the physical impossibility 
of carrying through large enterprises without a medium 


33 


MONEY 


of exchange. A poor medium is bad enough. At times the 
depreciated Russian money became so inconvenient that 
a traveler who took enough money with him for a long 
journey was forced to use much of it to pay excess-bag¬ 
gage charges. If there had been no medium of exchange, 
the purchasing agent for the builders of the Union Pacific 
Railroad would have been obliged to take with him a 
train load of goods wherever he went. Or imagine, as 
another example, the problems that would have been in¬ 
volved, in addition to all that were encountered, in an 
attempt to organize and operate, without a financial 
basis, the 228 companies located in 127 cities and towns 
in 18 States, which were combined to form the United 
States Steel Corporation. This enterprise, to be sure, 
required the use of various agencies in addition to money. 
The point is that large-scale business operations, based 
as they necessarily are on an extensive division of labor, 
would be impossible without a monetary system. 

This world-wide interdependence of the agencies of 
production and exchange that is based on division of 
labor, says H. J. Davenport, might have developed with¬ 
out currency. “It is obvious,” he writes, “that in a so¬ 
ciety lacking any established medium of exchange, divi¬ 
sion of labor and specialization of employment might 
exist very much as in the present society”; 7 and, again, 
he says, “by trading and retrading, the possessor of any 
commodity for exchange would finally get possession of 
that particular thing he wanted.” 8 But is this obvious? 
Is it not obvious, on the contrary, that a society, in which 
a man who wants to buy anything has to use his time 
and labor in seeking a wire-cloth-ivory-boat series of ex¬ 
changes, could not possibly become the specialized indus¬ 
trial society of to-day? Without a medium of exchange, 
the division of labor and the facilities of exchange of our 


39 


MONEY AS A MEDIUM OF EXCHANGE 

day are not conceivable — not even in that theoretical 
world, peopled with a type of animal that never did exist, 
which some of the early economists often imagined for the 
sake of argument. 

Barter has all but disappeared ‘ 

Because of the convenience of making exchanges 
through the medium of money, barter has all but disap¬ 
peared. The ingenious chapter in B. M. Anderson’s “The 
Value of Money,” in which are enumerated various types 
of modern barter, and various other transactions which it 
seems better to call by some name other than barter, serves 
only to emphasize the fact that the volume of barter trans¬ 
actions, compared with the volume of money transactions, 
is so small as to be a negligible factor in all the larger, 
practical problems of business. In the want columns of 
the newspapers, we do, indeed, occasionally hear of a man 
who wishes “to trade a well-trained parrot for a violin.” 
But dealers in parrots and in violins have not found trad¬ 
ing of this kind so brisk that they are obliged to take it 
seriously into account. “ I think it can easily be shown,” 
says Dr. Anderson, “that barter remains an important 
factor in modern business life, especially if one extends 
the term barter, a little, to cover various flexible substi¬ 
tutes for the use of money and checks in effecting ex¬ 
changes.” 9 But when anything is used as a medium of 
exchange, whether or not we call that medium “money,” 
we no longer have barter. Where, for example, payments 
for labor are made in orders on company stores, the trans¬ 
actions are effected through media of exchange. “Where 
bills of exchange are used in internal trade extensively,” 
says Dr. Anderson, “we have a highly important substi¬ 
tute for money and deposits, which functions as barter.” 10 
Should we not say, rather, “which functions as money”? 


40 


MONEY 


All these operations make use of media of exchange: 
barter, on the contrary, is the direct exchange of goods 
for goods. It is precisely because of the inconveniences of 
barter that traders, rather than attempt to do business 
without any medium of exchange at all, have devised 
so many permanent substitutes for primitive forms of 
money. It is for this reason, also, that in times of panic 
men resort to numerous other devices that temporarily 
serve as money. In our monetary theories, it is true, we 
must take due account of all such transfers. Failure to 
take them into account has led to various fallacious state¬ 
ments about equations of exchange and the relation of the 
quantity of money to prices. 11 But to call such trans¬ 
actions “barter” is confusing. 

Summary 

The gist of what we have said may be summed up in a 
single sentence: The use of a medium of exchange has 
been an indispensable means by which man has devel¬ 
oped the specialization and cooperation which character¬ 
ize modern industry, accumulated the present vast store 
of surplus wealth, created modern nations, and made 
possible a standard of living for the rank and file of labor¬ 
ers that was beyond the reach of even the cattle kings of 
primitive times. A return to barter as the chief means of 
trade is unthinkable. 12 Whatever improvement we are 
to make in the economic order must be made on a mone¬ 
tary basis. It behooves us, therefore, to know as much as 
possible not only concerning the ways in which money 
facilitates the work of the world, but also what ways 
there are, if any, in which money hinders the work of the 
world. 


CHAPTER IV 

MONEY AS A STANDARD OF VALUE 

Before the World War a carpenter in Vienna loaned 
three thousand Austrian gold crowns, the savings of a 
lifetime, the equivalent of a full year’s wages. After the 
War the debtor returned to the carpenter, in full legal 
settlement, three thousand depreciated paper crowns, the 
wages of three days’ labor. Thus does a shifting currency 
make a mockery of thrift. Still further to illustrate the 
instability of money, Joseph Szebenyei tells of a traveler 
in Vienna, who offered the waiter in a second-class res¬ 
taurant a twenty-dollar gold piece in payment for a din¬ 
ner bill of three hundred kronen. The bewildered waiter, 
after examining the treasure with curiosity and delight, 
went to the proprietor and said, “Here is a gentleman, 
sir, who wants to pay with a twenty-dollar gold piece. 
How much am I to give for it?” Having received in¬ 
structions from the landlord concerning current rates of 
exchange, the waiter returned to the guest and said seri¬ 
ously, “ I am to give you as much change, sir, as you de¬ 
sire,” 1 the full amount, presumably, being more than the 
traveler could readily carry away with him. These inci¬ 
dents show how far short money can come of being a 
standard of value, or a standard of deferred payments. 
No matter how much value a monetary unit may measure 
at any one time, it may soon be no measure of value at 
all. 2 

On the other hand, we have not heard of a dry-goods 
merchant, even in Austria, saying to a customer, “I am 
to give you, sir, as many yards as you desire.” The yard- 


42 


MONEY 


stick is a standard — that is to say, a virtually invariable 
unit. So zealously is the yardstick guarded against fluc¬ 
tuation in length that the visitor in Washington who 
wishes to observe the standard yard, in the glass case in 
which it is kept at uniform temperature, must view it 
through a telescope, lest the heat of his body might change 
the length of the bar one ten thousandth part of an inch. 
How ridiculous it would seem to substitute for this stand¬ 
ard yard the waist measurement of the President of the 
United States! How the unit would have varied during 
recent administrations! Yet at one time the “yard” act¬ 
ually did vary with the girths of the chieftains; and the 
monetary “standards” of the world still do vary beyond 
the physiological ranges even of the fat lady and the liv¬ 
ing skeleton at the circus. That is why, since 1914, the 
use of index numbers of prices to measure the shifting 
values of monetary units has spread rapidly, though no¬ 
body has needed an index number to keep track of the 
length of the yardstick. It is a true standard: money is 
not. 

It is said that the chief difference between a money 
economy and a barter economy is due to the introduction 
of something whose value varies but little. “Money,” 
says Professor Alfred Marshall, “tends to steady the 
market.” 3 With the statement that money introduces 
into the processes of exchange a commodity whose value 
might be made virtually constant, many would agree: 
others would not agree. The fact is, however, that mon¬ 
etary units have never measured purchasing power with 
a constancy approaching that of our units for measuring 
space, or temperature, or force. Since the World War 
began, money “standards” have been chaotic rather than 
constant. Whatever money might have done, if other¬ 
wise administered, it has, in fact, during the past few 


MONEY AS A STANDARD OF VALUE 


43 


years unsteadied the markets of the world. The folly of 
thinking of money as a standard should be widely pro¬ 
claimed until we succeed — if we ever do succeed — in 
making it a standard. 

The “Gold Standard” is not a Standard of Purchasing Power 

When money is on a gold basis, it is a standard of pur¬ 
chasing power for one commodity, and only one. As long 
as the gold basis is adequate, the power of money to pur¬ 
chase gold does not change. This is an advantage to 
dentists and goldsmiths: they know precisely what weight 
and fineness of gold their dollars will buy, year in and 
year out. Other people are protected to the same extent; 
they know that their dollars will continue to be standards 
for the purchasing of gold. But not for anything else. 
Unfortunately, it is almost always something else that 
they want to purchase. 

Paper money may be on a genuine gold basis — that is 
to say, actually and freely convertible into gold at a fixed 
parity up to the limits of the demand for conversion — 
and yet be unstable in purchasing power. So far does the 
gold basis fail to insure stability that the United States 
gold-supported dollar of 1920, as most men found to their 
sorrow, was worth scarcely more than one third of the 
dollar of 1913. Even in time of peace, the fact that paper 
money is convertible into gold does not make it a stand¬ 
ard of purchasing power. In point of fact, as Jevons long 
ago demonstrated by means of index numbers of prices, 
the value of gold money has varied greatly from time to 
time. During the twenty years preceding 1809, gold 
prices doubled, which is the same as saying that the value 
of gold was reduced fifty per cent. During the next forty 
years the situation was reversed: the value of gold 
doubled and prices were cut in two. Then followed a 


44 


MONEY 


period of rising prices up to 1873, during which the pur¬ 
chasing power of gold was reduced about one third. 
From 1873 to 1896 money appreciated in gold-standard 
countries about one quarter. William W. Carlile appears 
to be in error when he says that ‘ 4 an appreciation of gold 
as compared with commodities generally is in truth some¬ 
thing that only happens during a panic.” 4 It happened 
in all gold currency countries throughout the period from 
1873 to 1896. From 1896 to 1914, on the other hand, 
money depreciated about one third. Some of these 
changes in the purchasing power of the dollar are shown 
graphically in Figure 3. 6 The index of commodity prices 

THE VALUE OF THE GOLD DOLLAR. 

Measured in Goods at Wholesale. 



I860 1865 1896 I9EO 

Figure 3 


Pre-War Year 
1913 

STANDARD OF 
COMPARISON 


Why the Cost 
of Living 
Fluctuates 


in England, compiled by Augustus Sauerbeck, based on 
the average of 1867-1877 as 100, shows a rise from 74 in 
1849 to 111 in 1873, and a drop from 111 in 1873 to 61 in 
1896. In view of all these facts, we cannot escape the con¬ 
clusion that gold-supported money, both in time of peace 




MONEY AS A STANDARD OF VALUE 


45 

and in time of war, has proved unreliable as a standard 
of purchasing power. 

That the price-level does not vary directly with the 
stock of monetary gold is shown in Figure 4- 5 During the 
greater part of the years 1917, 1918, and 1919, gold re¬ 
serves in the United States remained nearly constant. 
The chart, however (using 1914 as the base year), shows 


PRICES IN RELATION TO GOLD 



that wholesale prices during this same period shot up 
from about 150 to about 250. During the next two years, 
vast gold reserves did not prevent prices from going 
down. From 1910 to 1915, there was a large production 
of gold but unusually slight fluctuations in the price- 
level. Evidently the stock of gold may go up while 



















46 


MONEY 


prices go down, or vice versa; or prices may stay about 
where they are, while stocks of gold increase. It is only 
over long periods of time that fluctuations in gold pro¬ 
duction have much to do with the price-level. 

Gold Itself is Unstable in Exchange Value 

A gold basis evidently does not stabilize the purchas¬ 
ing power of the superstructure of paper certificates and 
bank credit. But would it not be possible to have a stable 
dollar if all money were either actual gold coins or paper 
certificates backed by ioo per cent of gold reserves? Far 
from it; for gold itself would still be unstable in purchas¬ 
ing power. The value of gold, like that of any other com¬ 
modity, is affected by changes in supply and demand, the 
contentions of the reformers to the contrary not having 
interfered in any way with the operations of these funda¬ 
mental forces. Both the supply of gold and the demand 
for gold not only may change from year to year, but are 
certain to change. The supply of gold may be increased 
suddenly by the discovery of new mines or new processes: 
it may be increased a thousandfold by the invention of 
methods of making gold out of baser metals or extracting 
it from the sea — achievements that are no more chimer¬ 
ical than the radiophone. The demand for gold, on the 
other hand, even if gold were the only medium of ex¬ 
change, might be altered at any time by changes in popu¬ 
lation, in fashions, in the amount hoarded, in the use of 
substitutes for gold in the arts, and, above all, by changes 
in the volume of transactions that required the use of 
gold. In short, even if gold were the only medium of ex¬ 
change, neither the demand for gold nor the supply of 
gold would naturally fluctuate in any known or predict¬ 
able relation to fluctuations in the work that money is 
called upon to perform. Therefore, gold itself would 
fluctuate in purchasing power. 


47 


MONEY AS A STANDARD OF VALUE 

As a matter of fact, various commodities at various 
times have proved more nearly constant in exchange 
value than gold. In the United States, during one period, 
a depositor who wished to protect his savings against any 
variation whatever in exchange value could have achieved 
this purpose most nearly, it appears, by taking his dollars 
out of the savings bank and investing them in carpets. 
Carpets came nearer than dollars to being a standard for 
measuring purchasing power, in the sense in which the 
yardstick is a standard for measuring carpets. In other 
words, the exchange value of carpets, in terms of com¬ 
modities generally, varied but little. In England, during 
another period, nitrate of soda was the only commodity 
of all those in the Sauerbeck list that remained virtually 
constant in purchasing power. 6 

Nevertheless, in gold-standard countries gold is still re¬ 
garded by many people as fixed in value. Even Mr. Edi¬ 
son falls into this error. He says that the miner has a 
great advantage over the farmer, because the miner can 
present his gold at the mint at any time and get full value 
for it, whereas the farmer never can tell how much he will 
be able to get for his products. This difference is imag¬ 
inary. Both the farmer and the miner get “full value” 
for whatever they sell: that is to say, they get whatever 
the market value happens to be at the time of sale. Both 
gain at certain times, and lose at other times, because of 
the fluctuating exchange values of their products. 

The mistaken idea about the fixed value of gold leads 
many people to believe that the value of gold determines 
the purchasing power of the paper money that is based on 
gold. It would be nearer the truth to say that the pur¬ 
chasing power of the gold, in gold-standard countries, is 
determined by the value of the paper money and all the 
other money of which the gold is a small part. If it were 


MONEY 


48 

not for the use of paper money and bank credit based on 
gold reserves, the United States gold dollar would now be 
much higher in purchasing power; for, if gold dollars had 
to perform all the work of exchange, they would be in even 
greater demand. In short, although the value of gold has 
always varied widely, its value in gold-standard countries 
has not fluctuated as widely during the past few decades 
as it would have fluctuated had gold been the only me¬ 
dium of exchange. Some critics of the Federal Reserve 
System and of the bank credit and paper money that it 
supports overlook the fact that our dollar comes nearer to 
stability than would have been possible had every dollar 
been made of a fixed quantity of gold. The fact is that 
every change in the price-level is a change in the purchas¬ 
ing power of gold: as prices go up, the value of gold goes 
down. And this would be the case, if gold were the only 
medium of exchange. 

Inconvertible Paper Money is Still Worse 

To abandon the gold basis, however, in favor of a paper 
basis of the Lenin-Trotsky type is to plunge into chaos. 
Paper money, when it is not freely convertible into some¬ 
thing which is regarded as valuable and generally ac¬ 
cepted in exchange for goods, has usually been even less 
reliable, as a standard of purchasing power, than gold or 
silver. The history of every country furnishes evidence. 
During the war of the American colonies for independ¬ 
ence, the irredeemable Continental issues fell off in pur¬ 
chasing power until the phrase “not worth a continental” 
became a byword. Early in the nineteenth century Spain 
issued paper pesetas until they had depreciated ninety- 
six per cent, although the Government still declared them 
to be legal tender. During the same period Austria 
printed so many florins that eight of them would not buy 


MONEY AS A STANDARD OF VALUE 


49 


a single silver florin. In Argentina, in 1840, fiat money 
was issued in such quantities that it took thirty-two times 
as many paper pesos as formerly to buy an ounce of sil¬ 
ver. In Uruguay, in 1875, paper money increased in vol¬ 
ume until the premium on gold ran as high as 875 per 
cent — that is to say, until it took 875 paper dollars to 
equal in purchasing power gold dollars. Following 
the Satsuma insurrection, Japan issued inconvertible 
Government notes until the premium on silver was sev¬ 
enty-nine per cent. These lessons are taken at random 
from the pages of monetary history. 

In spite of these lessons, many European countries, 
during the World War and after, plunged into debauches 
of irredeemable paper money. In some of the countries 
the plunge was not taken in ignorance of the conse¬ 
quences, but with the idea of averting what seemed to 
somebody to be greater disaster — the overthrow of the 
party in power, perhaps, or deeper business depression, 
or even revolution. In England, money fell to about one 
third of its pre-war purchasing power. In France it fell 
further; in Italy, still further; while in Germany the mark 
fell far below one seven thousandth of its pre-war exchange 
value. In Austria, where paper money poured forth from 
the printing-presses until it cost more to print a krone 
than a krone would buy, the thrifty proprietor of “Kro¬ 
nen Bier” used paper money for labels in order to reduce 
his printing bill. It remained for Russia to say the last 
word concerning irredeemable paper money as a standard 
of value. Lenin and Trotsky pursued the policy of fiat 
money to its logical conclusion. As a result, a Russian 
ruble, which was worth about forty-seven cents on the 
pre-war gold basis, became not worth a peasant’s notice 
on no basis at all. It took more than his pockets would 
hold to buy a copper cent’s worth of bread. 


50 


MONEY 


Certain as it is that money is not a standard merely be¬ 
cause it is based on the fiat of a government, it is equally 
certain that money is not a standard merely because it is 
based on land, or on stores of wheat, or on any other farm 
products. Commodity money, however, is a subject cf 
such perennial interest and such real importance that we 
shall deal with it in a separate chapter. 

Equally futile is the attempt to stabilize the purchas¬ 
ing power of monetary units by having them ‘ 1 represent ’ ’ 
energy units, or labor-hours, or production capacity, or 
merely anticipated output of wheat or fertilizers. It 
would be just as effective to have money “represent” 
the sands of the sea. It would be far more effective to 
have it represent the annual consumption of postage 
stamps at fixed postal rates. “Representation,” unless 
it means actual and free convertibility into a commodity 
having the chief characteristics of gold, is not necessarily 
any restraint at all upon issues of money. 

Conclusion 

We must conclude that everyday thinking concerning 
economics would be relieved of one of its many confusions 
if our unstable monetary units were not again referred 
to as standards of value. In connection with personal 
affairs — investments, insurance, family budgets and 
daily purchases — even those who regard these remarks 
as commonplace, do not consistently take them into ac¬ 
count. In business enterprises as well, men who are per¬ 
fectly aware that price-levels are changing, nevertheless 
frequently fall into economic error because they disre¬ 
gard the full effects of these changing price-levels. Look¬ 
ing upon their book profits as if dollars were standards of 
value, they joyously expand their operations, and com¬ 
mit themselves to future payments in money, merely to 


MONEY AS A STANDARD OF VALUE 


5i 


find, after the crisis, that their profits are only in depre¬ 
ciated goods while their debts are legally payable only in 
appreciated dollars. Relying on money as a standard 
measure of foreign trade, a leading financial journal as¬ 
sured us, early in 1921, that “exports from the United 
States to Germany in the fiscal year which ends with 
June, 1921 . . . will be of greater value, measured in good 
American dollars, than in any year in the history of our 
trade relations.” “Good American dollars” are good for 
how much? When we answer that question correctly, we 
find that exports to Germany in the year in question were 
really less than they had been for twenty years. In that 
case, as in many others, the false conception of money 
as a standard of value obscured its actual effects on the 
economic order. 

Even to-day, after the experience of the past six years, 
there are leaders in the world of commerce and finance 
who insist that the American gold dollar is a satisfactory 
standard, stable in purchasing power. In the editorial 
columns of a leading financial publication we read: “To¬ 
day this dollar, in the confusion of finances, the disorder 
of so-called ‘exchanges,’ the debasement of foreign cur¬ 
rencies, stands alone, unchanged and unchanging. . . . 
Because it exemplifies the gold standard, in itself it is 
stable_Why or how has its ‘purchasing power’ di¬ 

minished? This is a supreme fallacy — it has not. ... It 
stands out above the carping critics who would make it a 
shifting thing. . . . Around it whirled a fateful war, and it 
stood fast. . . . But only because back of the American 
dollar is the gold dollar, and back of the gold dollar is the 
gold standard —and that, though ‘tried,’ is not found 
wanting.” 7 In another editorial we read that “the gold 
standard as a standard does not change at all, ’ and the 
American dollar is the “sole and chief representative of 


5 2 


MONEY 


stability in the monetary world of to-day.” 8 Thus is ex¬ 
pressed that unreasoned faith in the stability of the gold 
standard which has become a cardinal point in the creed 
of many men, and which prompts them hastily to reject 
all proposals for improving the currency — the worthy 
along with the unworthy. 

We agree with these men that the gold basis of money 
should be retained. We agree, however, not because gold 
is a standard of purchasing power, for it is not a standard, 
but for reasons which we shall set forth in another chap¬ 
ter. We must admit that gold price-levels do change. If, 
while we are being carried away by a flood, we still insist 
that the level of the river does not and cannot change, 
we may interfere with the adoption of flood-prevention 
measures. Repeated denials that we have confusion of 
monetary values under the gold “standard” may not be 
enough to save us from a flood of fiat money. If it ap¬ 
pears to most people that our leaders in politics and in 
finance are not disposed to face the facts and devise safe 
and practicable remedial measures, it is all the easier for 
such wizards as Henry Ford and Thomas Edison, and 
many less distinguished reformers, to arouse popular en¬ 
thusiasm for measures that would merely lead us from 
monetary confusion to monetary chaos. 


CHAPTER V 

MONEY AND INFLATION 


Many current controversies about inflation are due not to 
conflicting ideas but to conflicting uses of the same word. 
When a nation has too much money, it is said to have 
inflation: that is about as near as we can come to an 
accepted definition of the term. As to what constitutes 
having too much money, there is no agreement. No na¬ 
tion has ever had enough money to satisfy everybody. 
When dollar-profits and dollar-wages are increasing, even 
though the increase in the number of dollars is wholly off¬ 
set by the decrease in the value of the dollar, most people 
feel a glow of prosperity. At such times they object to 
calling the currency unpleasant names: they prefer to 
speak of its elasticity and of the creative power of expan¬ 
sible bank credit. 

One economist ventures to define inflation as “an ab¬ 
normal increase of money ”; but this definition only trans¬ 
fers our difficulty to the word “abnormal’’ — a word that 
brings with it more or less confusion whenever it enters 
the realm of economics. What is an “abnormal’’ increase 
of money? Has the monetary world ever been in a “nor¬ 
mal” condition? To these questions, there is no accepted 
answer. Until we can locate the normal point, we cannot 
tell what is abnormal. Other writers confine the term 
“inflation” to that part of the total volume of money 
which is responsible for a rise in prices. Bertil Ohlin, for 
instance, says inflation is that rise in prices the causes of 
which are found on the side of money, and, other things 
being equal, finds its expression in an increase in the cir- 


54 


MONEY 


culation. 1 One trouble with this definition is that other 
things never are equal: they vary with monetary changes, 
and they vary independently of monetary changes, and it 
is impossible to measure all their variations. Conse¬ 
quently we never can tell precisely what part of a rise in 
prices is due to an increase of money. 

Frequently inflation is defined as a quantity of cur¬ 
rency or bank credit, or both, in excess of “the legitimate 
requirements of business.” So far, so good: but what are 
the legitimate requirements of business? The answers to 
this question are many and varied: they agree, for the 
most part, only in being hazy. Such phrases as “the re¬ 
quirements of commerce,” “trade needs,” “the financial 
demands of industry,” and “enough money to do busi¬ 
ness with,” while appearing to be quantitatively exact, 
are in reality far from it. As they are used in everyday 
discussions, these phrases merely add confusion to sub¬ 
jects that are already confusing. Prices and volume of 
money are definite factors, subject to approximately 
exact measurement; but what is the measure of “legiti¬ 
mate trade needs”? 

A Definition of Inflation 

Is it possible to define inflation with reference to trade 
needs and with quantitative precision? Let us see. If we 
are right in the contention that the chief monetary need 
of business is enough money so distributed as to sustain 
production, year in and year out, our interest in the vol¬ 
ume of money centers around its effect on the price-level. 
After all, most people care nothing about fluctuations in 
the general supply of money until something startling 
happens to prices. Any increase in currency which ac¬ 
tually financed an increased volume of trade, without a 
change of the general price-level, would not be generally 


MONEY AND INFLATION 


55 


condemned. In other words, there would be no wide¬ 
spread objection to increased purchasing power com¬ 
mensurate with increased trade. If the world had expe¬ 
rienced extraordinary expansions of currency only in 
connection with equally extraordinary trade revivals, 
accompanied by no extraordinary rise in prices, it is safe 
to say that there would have been no controversies over 
inflation. It seems best, therefore, to define inflation with 
reference to changing price-levels. 

If we use the term “inflation” to denote any increase 
in the volume of money that is accompanied by a rise in 
the general price-level, we confine ourselves to a definite 
and logical use of the term, and one that directs atten¬ 
tion at once to the practical monetary problem with 
which business is to-day chiefly concerned. Similarly, we 
may well define “deflation ” as any reduction in the vol¬ 
ume of money that is accompanied by a fall in the general 
price-level. That is the only sense in which the words in¬ 
flation and deflation will be used throughout this volume. 
As we shall see in the tenth chapter, it is possible to have 
an increase in the price-level without an increase of 
money, or an increase of money without an increase in the 
price-level; but there must be increases in both, accord¬ 
ing to our definition, before there is inflation. Controver¬ 
sies are thus avoided over the question what is normal, 
and the question whether, during a given time, we have 
inflation, or deflation, or neither. We do not now speak of 
normal and abnormal degrees of fever. Any rise at all in 
the temperature of the human body above ninety-eight 
and three-fifths degrees denotes fever. On this point, we 
do not argue or even ask the opinions of doctors: we read 
the thermometer. If we adopted an equally definite use of 
the term “inflation,” we should not need the diagnosis of 
economic doctors: we should read the treasury and bank 


MONEY 


56 

reports and the index numbers of prices. If we found that 
the volume of money and the price-level were rising, we 
should know that the currency had been inflated. 2 

It is true that a rise in the price-level can take place 
without any increase of money in circulation: a decrease 
in the volume of goods may have the same effect upon 
prices as an increase in the volume of money. Just as we 
can increase the size of a balloon either by pumping in more 
air, or by decreasing the outside pressure, so, as a rule, we 
can increase prices either by pumping more dollars into 
the monetary circulation, or by decreasing the pressure of 
the work that money has to perform. It seems best, how¬ 
ever, not to extend the term “inflation” to cover failures 
to reduce the money in circulation when prices begin to 
rise. Such an extension of the use of the term would be at 
variance with its derivation, and would, moreover, leave 
the term less definitely applicable to the actual, current 
monetary problems of the world. 3 

The Vicious Spiral of Inflation 

Inflation leads naturally to further inflation. Once the 
upward movement of prices has started, there are at 
present no forces in the ordinary operations of business 
and finance sufficient to correct the fault in due time. If 
the volume of money is freely “responsive to the needs of 
business,” it is responsive to the needs of inflation. When 
prices are rising, no matter what the causes may be, 
prices tend to rise still higher. Higher prices lead to 
higher wages; higher wages lead to still higher prices: 
higher dollar-valuations of products are used as bases for 
larger bank loans; larger bank loans put more money into 
circulation and thus provide buyers with the means of 
further bidding up prices: speculation still further stimu¬ 
lates the upward movement; and the upward movement 


MONEY AND INFLATION 


57 


still further stimulates speculation: and so on until a 
crisis is reached. In much the same way, the atoms of gas 
that flock around the end of a gas lighter increase in veloc¬ 
ity, thus producing heat, thus further increasing their 
velocity, thus producing more heat, and so on, until the 
gas bursts into flame. 4 

In Germany, for example, following the World War, 
the danger of continued inflation decreased the value of * 
the mark in foreign trade; this increased the real burden 
of Government expenses at home and reparation pay¬ 
ments; this, in turn, led the Government to call upon the 
Reichsbank for new loans which caused still further de¬ 
preciation of the mark. All this stimulated further specu¬ 
lation in goods, which withheld goods from the markets 
and decreased the amount of money available for other 
uses, and thus led to new demands for new issues of cur¬ 
rency, which led to still higher prices, which incited the 
people to demand larger doles, which increased the Gov¬ 
ernment budgets, and forced upon those in power the 
recurrent alternative of printing more marks or being 
thrown out of office. Thus, wherever the volume of money 
is not regulated in the interests of a stable price-level, the 
vicious spiral of inflation carries a nation on to a crisis or 
to a period of depression. 5 

Inflation through Bond Issues ’ 

National financing by means of taxes is less costly than 
financing by means of loans because loans are far more 
prolific sources of inflation. This objection to loans would 
not hold if all payments for bonds were made from cur¬ 
rent income. In that case (if the velocity of money from 
use in consumption to another use in consumption 
remained unchanged) the amount thus raised and ex¬ 
pended by the Government would be exactly offset by 


58 


MONEY ' 


the amount saved by subscribers and invested in bonds. 
No new dollars would be placed in circulation: therefore 
no new dollar-demands would appear for the existing vol¬ 
ume of goods. But, as a matter of fact, a large part of the 
money paid for bonds is borrowed from banks. Indeed, 
the slogan of the first Liberty Loan Campaign was 
“Borrow and Buy Bonds.” This borrowing involves ex¬ 
pansion of bank credit without increased production of 
goods; and that means inflation. As prices go up, some 
of the borrowers have to use their bonds as security 
for further loans. So new dollars continue to press their 
claims in markets where there are no new goods. 

In so far as war is financed by taxes, it is less likely to 
bring about inflation through expansion of bank credit. 
This is true, in the first place, because banks regard 
money paid for taxes as money spent, and are not inclined 
to lend money for this purpose, whereas they look upon 
money paid for bonds as money invested. Banks feel 
safe in advancing money for the purchase of Government 
bonds, which have a rather stable market value and yield 
a steady income; but banks are more wary about lending 
money to enable a borrower to obtain a tax receipt, which, 
like a receipted bill for last month’s groceries, has no 
market value and bears no coupons. In the second place, 
bonds lead to inflation more readily than taxes because 
the taxpayer also prefers bonds to tax receipts. He hesi¬ 
tates to borrow money to pay his taxes as he hesitates to 
borrow money to pay his coal bill, for in either case all he 
has left is a debt. But why have any reluctance in ac¬ 
cepting a loan for the purpose of buying a bond? There 
is the bond to show for the debt; and there, in addition, 
is the semi-annual interest. Prudent man that he is, he 
would reduce his consumption — perhaps even give up 
his automobile — rather than go into'debt to pay his 


MONEY AND INFLATION 


59 


taxes. But why should he save any more than usual in 
order to buy a bond, when he can borrow money now and 
repay the loan at any time he pleases with the proceeds ot 
the sale of the bond itself? It is precisely this universal 
difference between the attitude toward bonds and the 
attitude toward taxes that makes it seem to governments 
much easier to pay for wars with loans than with taxes. 
For the same reason, inflation is liable to increase in pro¬ 
portion as a nation resorts to loans rather than to taxes. 
In this connection, Sir Drummond Fraser points out that 
in Great Britain heavier taxation during the War would 
have prevented the greater part of the rise in the cost 
of living, the violent fluctuations in the rates of foreign 
exchange, and the consequent hindrance to trade. 

Taxation costs a Nation less than Bond Issues 

Payment of war bills by means of taxation costs a 
nation less in the end than payment by means of bond 
issues, for it forces a general limitation on consumption. 
Apparent postponing of payment, on the other hand, 
through the sale of bonds, encourages extravagance. It 
is often said that when we go to war, we pile up huge 
debts for our children to pay, in the form of interest and 
principal on government bonds. But there is no way 
whatever for the world to pass on its war debts; they are 
paid day by day, hour by hour. The sunken ships, the 
wasted food, the exploded shells, the hours of labor, the 
mangled bodies, will not be supplied by future workers. 
Everything that is consumed has already been produced. 
Any one nation, to be sure, can postpone paying its war 
bills, in so far as it makes external loans; but when a 
country borrows only from its own people, it pays for the 
whole war out of past and current savings. The Liberty 
Bonds issued by the United States were not devices for 


6o 


MONEY 


making future generations pay for the War. These bonds 
transfer obligations, not from one generation to the next, 
but from some people to other people. When the two 
billions of the First Liberty Loan are paid, two billions 
will be taken from some people and paid to others. Some 
of these people will pay in taxes just about what they re¬ 
ceive for their bonds; others will pay less, others more. 
The whole country will be not a dollar richer or poorer 
than before the two billions changed hands; and not a 
dollar of that money will be used to pay for the War. 

Some people who get as far as this in their thinking 
conclude that a country loses nothing by making internal 
loans. What difference does it make, they ask, if in the 
end we merely pass the money around among ourselves? 
Indeed, may not those of us who pay little or no direct 
taxes be better off than before, since, in any event, we 
shall not be called upon to pay the debt? Such people 
overlook the fact that there is a negative sense in which 
wars must be paid for by all the people who survive. In 
this respect a war is like an earthquake or a flood: after 
the disaster there is less material wealth to hand on to 
succeeding generations. Whatever is destroyed is gone: 
that is the immediate and certain result. That, rather 
than the fact that the bonds must be paid, is the main 
economic concern of the next generation. Since individ¬ 
uals rightly look upon bonds as investments rather than 
as taxes, it is easier for governments to raise money by 
selling bonds and therefore easier to be extravagant. 
Consequently, if succeeding generations could plead their 
own cause, they would urge that all current consumption 
be paid for by means of taxes that do not involve infla¬ 
tion of the currency. 

Here, again, we meet the conflict between individual 
and group interests. From the standpoint of the group, 


MONEY AND INFLATION 


61 


government bonds are nothing but claims against future 
taxes. The only way the people can collect interest or 
principal on the bonds is to pay it themselves. That is all 
the bonds promise: they are solemn obligations of the 
people to pay themselves certain amounts of money in 
the future out of future savings. A bundle of receipted 
butcher’s bills is as much national wealth as a vault full 
of government bonds. But to the individual owner, a 
bond means real purchasing power. In any case, he will 
be obliged to pay his taxes in the future, whatever they 
are. The more bonds he has, the more money he will have 
for the purpose. What he fails to see clearly is that if all 
war bills were paid by taxes collected during the war, and 
if subsequent taxes were levied on just as equitable a 
basis, the war would cost him and all the other taxpayers 
less than when bonds are sold by means of inflating the 
currency. 

Inflation is Indirect Taxation 

Whether the Government inflates the currency in this 
way or by printing money, the result, though never called 
by the forbidding name of taxation, has all the effects of 
taxation. A simple illustration will make this clear. Let 
us suppose that there are a million dollars of purchasing 
power in the hands of the people. Let us suppose that each 
dollar will buy one unit of commodities. If, then, the 
Government obtains a million new dollars, through in¬ 
creasing the volume of bank deposits or the volume of 
paper currency, and with this new money appears in the 
markets as a competitor for the existing commodities, 
the result is likely to be that the people can buy with 
their dollars only half as much as before, or even less. 
The Government takes the rest Thus, the people have 
been taxed as effectively as though the volume of money 


62 


MONEY 


in circulation and the price-level had remained the same, 
and the Government had taken from the people in direct 
taxes fifty per cent of their money. Actual cases are al¬ 
ways far more complicated and more extensive than our 
simple illustration, but the effect of inflation is always 
the same: multiplying units of goods and units of money 
by millions obscures but does not alter the principle. 
Whenever the Government resorts to inflation as a means 
of paying its bills, it resorts to clandestine taxation. 

Disastrous Effects of Unstable Money 

Shifting price-levels are disastrous — morally, socially, 
economically. Where the price-level happens to be is of 
minor importance: the major need is that it should stay 
where it is. Business can proceed on one level just as well 
as on another, once the level has become stabilized, just 
as a ship can sail as serenely on the waters of Lake Su¬ 
perior as on the lower level of Lake Huron, once the ship 
has passed through the locks. It is the process of chang¬ 
ing levels and the frequency of the change that retard 
progress. If there is sustained production of goods ap¬ 
proaching maximum capacity, and sustained buying by 
consumers commensurate with that capacity, the price- 
level is satisfactory, wherever it happens to stand. 

None the less true is this if we admit that, under exist¬ 
ing economic conditions , a uniform price-level is neither 
possible nor desirable. In later chapters of this book, and 
in Poliak Publication Number 3, on Costs and Profits , we 
shall endeavor to show that, as production is now financed 
and as profits are now distributed, the desired relation¬ 
ship between the making of goods and the using up of 
goods cannot long be sustained. Wherever business is sub¬ 
ject to sharp cyclical fluctuations, shifts in the price-level 
become necessary at the top in order to dispose of exces- 


MONEY AND INFLATION 


63 

sive stocks, and at the bottom in order to bring about in¬ 
creased production more rapidly than would otherwise be 
possible. Maladjustments between money spent in pro¬ 
duction and money spent in consumption are sure to 
develop in such a way that nothing but a change in 
price-level can bring about a quick resumption of busi¬ 
ness activity. 

Inflation is Morally Disastrous 

There is a correlation, difficult to measure statistically, 
but easy to observe, between depreciated currencies and 
depreciated morals. Unstable monetary units are morally 
injurious because they are unjust. As a matter of justice, 
the dollars returned in payment for a loan should be the 
same as the dollars borrowed — the same in the only 
quality that matters, their purchasing power. Dollars 
are not standards of deferred payments unless their com¬ 
mand over the general range of commodities remains 
virtually the same, year in and year out. When their pur¬ 
chasing power changes, either the debtor or the creditor 
loses more than justice demands. Men sow where they do 
not reap, and reap where they do not sow. Our Austrian 
carpenter loaned his full year’s wages and received in 
full payment the wages of three days. In gold-standard 
countries, the injustice differs in degree but not in kind. 

Furthermore, inflation of the currency thrusts the 
financial burdens of a nation most disastrously upon 
people who are least able to bear them; on those with 
fixed incomes — clerks, teachers, some groups of wage- 
earners, and all people with small salaries; and on widows 
and orphans dependent on pensions, or insurance an¬ 
nuities, or savings bank accounts. Meantime, some hold¬ 
ers of goods and some speculators in the exchanges make 
vast fortunes out of the sufferings of others. In a remark- 


MONEY 


64 

ably sound and penetrating series of papers, published in 
1791, Pelatiah Webster describes the results of the con¬ 
temporary inflation. “If it saved the state,” he says, “it 
also polluted the equity of our laws;.turned them into 
engines of oppression and wrong; corrupted the justice 
of our public administration; destroyed the fortunes of 
thousands who had most confidence in it; enervated the 
trade, husbandry, and manufactures of the country; and 
went far to destroy the morality of our people.” 6 In short, 
governments, by means of excessive issues of paper money 
or forced loans from the banks, destroy the standards 
which they themselves have set up. Thus, by means of 
that “least covert of all forms of knavery, which consists 
in calling a shilling a pound,” 7 they deliberately repudi¬ 
ate large parts of their own debts. Sir Lancelot Hare is 
right when he insists that, whatever standard is adopted 
— whether it be gold or anything else — it is on the good 
faith of man as expressed through a nation’s government 
that the standard of measurement of value can alone 
depend. 8 

Inflation as an official source of revenue is in effect, 
as we have shown above, surreptitious and inequitable 
taxation: it is national, official repudiation of fundamen¬ 
tal principles of justice. The Liberty Bond issues in the 
United States, because they were floated partly by means 
of inflation, resulted in heavy indirect taxes, distributed, 
not in accordance with the ability of the people to pay 
taxes, but in proportion to their daily expenditures. Di¬ 
rect taxes are far better, for the victims know precisely why 
they have lost some of their purchasing power and who 
has taken it; but when a part of their purchasing power 
has been taken from them by means of inflation of the 
currency, they do not know what has happened and they 
put the blame anywhere but in the right place. Witness 


MONEY AND INFLATION 


65 

the indiscriminate condemnation of “profiteers.” Indeed, 
confusion of issues is often the official aim. Governments 
sometimes resort to inflation as robbers resort to chloro¬ 
form in order that they may meet with less resistance. 

Because shifting price-levels thus provide opportuni¬ 
ties to get something for nothing, inflation does the moral 
damage of encouraging extravagance and wild specula¬ 
tion, while it discourages thrift and labor. In describing 
the degenerating influences of one period of inflation, 
Andrew D. White says: “In city centers came a quick 
growth of stock jobbers and speculators; and these set a 
debasing fashion in business which spread to the remotest 
parts of the country. Then, too, as values became more 
and more uncertain, there was no longer any more motive 
for care or economy, but every motive for immediate ex¬ 
penditure and present enjoyment. So came upon the na¬ 
tion the obliteration of the idea of thrift. Luxury, sense¬ 
less and extravagant, set in; and this, too, spread as a 
fashion. To feed it, there came cheating in the nation at 
large, and corruption among officials and persons holding 
trusts; and while the men set such fashions in business, 
private and official, women set fashions of extravagance 
in dress and living that added to the incentives to cor¬ 
ruption. Faith in moral considerations, or even in good 
impulses, yielded to general distrust. National honor was 
thought a fiction, cherished only by enthusiasts. Patriot¬ 
ism was eaten out by cynicism.” 9 It is impossible to tell, 
merely from reading this account, whether it was written 
to describe the condition of France during the “Missis¬ 
sippi Bubble” orgy of speculation in the early eighteenth 
century, or the similar troubles of Austria in the early 
nineteenth century, or the era of Continental currency in 
the United States, or conditions in Germany in 1922, or 
— what the passage was, in fact, written to describe — 


66 MONEY 

the experience of France during the Revolution with 
paper assignats. 

Similar results have always followed inflation. The ac¬ 
count given by the American Consul, T. R. Jemigan, of 
conditions in Japan describes the moral consequences of 
extreme inflation at all times and in all countries, for cer¬ 
tain human characteristics appear to have changed but 
little through the centuries. “ In the year 1881,” he says, 
“nearly everything in Japan had greatly risen in price, 
and as the great majority of the people considered only 
price, and not value, and ignored the wholly fictitious na¬ 
ture of the advance, it is not surprising that they im¬ 
agined it both solid and likely to endure, and thought 
themselves very prosperous and quite justified in launch¬ 
ing into much extravagant expenditure. Accordingly new 
farmhouses sprang up in every province, new clothes and 
ornaments were freely purchased, land property became 
in great demand, and capital was inconsiderately bor¬ 
rowed at high rates of interest (and as inconsiderately 
lent by the national banks) and in general everybody re¬ 
joiced in hope and a sense of prosperity.” 10 Of the dis¬ 
astrous results in Japan, we shall have something to say 
presently when we discuss the evils of deflation. 

Travelers on the Continent after the World War found 
business men, professional men, and even laboring men 
“exchange mad”: gambling seemed to be their main oc¬ 
cupation. The following report is typical: “The con¬ 
stant depreciation of currency seems to have a deteriorat¬ 
ing influence upon morality. Newspapers are full of polit¬ 
ical scandals, public corruption, and the misdoings of 
bank swindlers, defalcators, and petty thieves. The re¬ 
spect for property is diminishing in proportion to its higher 
money value; and the amounts in which dishonesty deals 
are counted in millions.... To cheat the state, to trans- 


MONEY AND INFLATION 


67 

act crooked business is not looked upon as unfair: nor is 
it at all unusual — in Central Europe, at least. Mail rob¬ 
beries, tampering with valuable packages, are matters of 
everyday occurrence, and, indeed, are part of the routine. 
. . . Every wage-earner or salaried worker has to specu¬ 
late, barter, or steal in order to make both ends meet.” 11 
Under such conditions, feverish business activity, larger 
dividends and reserves, and full employment of workers 
are not evidences of prosperity that can last. “All busi¬ 
ness to-day,” said a German Government officer in 1922, 
“is merely a gamble in currency and exchanges.” 12 Such 
a moral breakdown is only in small part, if at all, the 
necessary aftermath of war: it is, however, the inevitable 
result of vast inflation. It is sure to come, to some extent, 
with any attempt to finance a nation by depreciating its 
currency. 

The alternative method of financing a nation is the 
rigorous moral exercise of abstinence, economy, and hard 
work. There have been many futile attempts to make 
people moral by government regulation, but no govern¬ 
ment has had the courage to make full use of one of the 
most effective methods at its disposal. Few things within 
the power of the state can do so much for public morality 
as the protection of the currency from excessive fluctua¬ 
tions in value. 

Inflation induces Social Unrest 

Inflation leads to social unrest; for, whenever certain 
groups, through no virtue of their own, are prospering, 
while other groups, through no fault of their own, are 
suffering, there is cause for protest against the established 
economic order. The protests may be in wrong direc¬ 
tions, for few people understand where their troubles be¬ 
gin. Meantime, their troubles are real and their resent¬ 
ment is righteous. 


68 


MONEY 


When there Is inflation, profits rise faster than wages, 
and rising profits inevitably incite a rising spirit of revolt. 
Workers everywhere are more likely to be content with 
low wages when business is bad than with high wages 
when business is good. No matter how much labor leaders 
and social workers may insist upon maintaining a given 
standard of living, the workers themselves are more likely 
to ignore standards of living and insist on a fair share of 
the profits. Their position is economically sound. For to 
take “the American standard of living,” or any other 
standard, as a basis for fixing wages is economic nonsense. 
It is as though a corporation should fix the dividend rate 
with reference only to the needs of stockholders, regard¬ 
less of the profits of the business. In deciding how many 
suits to make out of a bolt of cloth, a tailor does not first 
consider how many suits he would like to make: he first 
measures the cloth. Wage-earners, as a rule, do not think 
first of the standard of living they would like to maintain: 
they first try to measure the possibilities. The best meas¬ 
ure seems to them to be the profits. No wages whatever, 
no matter how far above the amount carefully figured by 
labor leaders or by economists as required “to keep a 
typical family of five in health and comfort,” will be sat¬ 
isfactory as long as workers believe that the condition of 
the business warrants higher wages. 

As the profits of war industries increased in England, 
laborers demanded “a fair share of the increase.” They 
had no means of knowing what a fair share would be, nor 
did they much care. It seemed to them that employers 
were making all they could make; there seemed nothing 
to do but follow the example. And as money-profits were 
really piling up, employers put up wages rather than run 
any risk of strikes. As long as prices continued to rise, the 
increased pay-roll was promptly provided by the in- 


MONEY AND INFLATION 


69 

creased prices of the products. The consumers of these 
products paid the bill. Wherever the employers had war 
contracts, on a cost plus commission basis, they had 
no objection to higher wages: the higher the wages, the 
higher the profits. In such cases, the consumers were all 
the people, and all the people paid in taxes, direct and in¬ 
direct, both the wages and the profits. Thus inflation 
leads to “the high cost of living” and to widespread dis¬ 
content. Says the French proverb, “After the printing- 
press, the guillotine.” 

As wages rose in the United States during the World 
War, wage-earners went into the markets with the expec¬ 
tation of buying more goods than they had been accus¬ 
tomed to buy with their old wages; for they were still 
more or less attached to the idea of money as a standard 
of value. They thought that, with more dollars than they 
had ever dreamed of getting, they ought somehow to be 
better off than ever before; yet they found that they were 
not as well off. They said, again and again, that they 
should be glad to return to their pre-war wages and pre¬ 
war prices. Some of them, in certain manufacturing cen¬ 
ters where the effect of higher wages on retail prices was 
immediately evident, asked their employers not to raise 
their wages again, since prices in the local stores went up 
faster than wages. The workers believed that somehow 
they were being fooled. They condemned employers, 
shareholders, “profiteers,” “Wall Street,” the Federal 
Reserve System; in short, they condemned everybody 
who seemed to be profiting by the War while they them¬ 
selves seemed to be losing. 

As wages were put up in “essential” war industries, 
they had to go up eventually in virtually all other indus¬ 
tries. The substantial increases in the pay of metal 
} workers, shipbuilders, and railroad men in the United 


70 


MONEY 


States, like the increases in the pay of munition makers 
in England, unsettled the economic order. Accepted re¬ 
lations between the wages of various groups of workers 
were upset. Unrest followed. As soon as the increased 
wages of munition workers were charged up to other 
workers, in higher prices and in higher taxes, the other 
workers demanded the wherewithal to pay the higher 
bills. But before they received their new wages, the bills 
were higher still. As money wages went up, real wages 
went down. So the workers demanded further increases. 
These increases promptly went into costs, and prices con¬ 
tinued to rise. For wages, as a whole, it was an uphill 
struggle to overtake prices which had started up the hill 
first and seemed to keep the lead without even a struggle. 
Thus the vicious spiral of inflation is always a cause of in¬ 
justice, and so of industrial unrest. 

In the United States, the Government added to the un¬ 
rest and to the mystery by declaring, in various awards, 
that the demand of wage-earners for increases in wages 
sufficient to meet the increased cost of living was a legit¬ 
imate demand. It was not legitimate, for it failed to take 
into account the goods side of the equation of exchange. 
There was a shortage of goods for use at home. On ac¬ 
count of the War demands of the Government and the re¬ 
duction in the number of workers available for peace¬ 
time production, there was necessarily a reduction in the 
supply of various kinds of goods available for domestic 
consumption. Wage increases could not alter that funda¬ 
mental economic fact. Somebody in this country had to 
get along with fewer goods than before the War. If any 
particular group of laborers succeeded in getting wages 
sufficient to buy what their wages bought before the War, 
it meant that some other laborers were bearing more than 
their share of the deprivations due to the shortage of 


MONEY AND INFLATION 


7i 


goods. For example, school teachers and Government 
employees, because their wages lagged farther behind the 
cost of living than the wages of railroad employees, were, 
in an important sense, paying a part of the increase in the 
wages of railroad employees. What some of the workers 
and some of the Government agencies appear to have 
overlooked is the fact that there is no possible way of dis¬ 
tributing the money of the country, or controlling its ’ 
supply, so that consumers will receive more than the ex¬ 
isting volume of goods. Under a barter economy, there 
could be no mystery about this. It was the use of a me¬ 
dium of exchange that is not a standard of value, rather 
than the War itself, that was the chief direct cause of the 
increased injustice, confusion, suspicion, strikes, sabo¬ 
tage, and relaxing of moral restraints. 

Inflation is Economically Disastrous 

In the stress of a nation’s need, inflation deceives the 
people generally, and often the Government itself, by 
making it seem easier than it really is to obtain the sinews 
of war — or the after-war sinews of bonus payments. On 
a boundless expanse of paper currency, any loan what¬ 
ever can be floated to-day and a larger one to-morrow. 

It is “easy money.’’ The trouble does not begin until the 
Government tries to exchange the money for goods; and 
the trouble for the country does not end until the easy 
money is offset by hard work. If the process of raising a 
war loan doubles prices, the Government finds when it 
spends the money that it can obtain only half the needed 
cannon and shells. The dollars themselves do not go 
to the front. Meantime, no pressure has been brought 
to bear upon the people to produce more and to con¬ 
sume less. On the contrary, as we have already seen, 
inflation promotes extravagance in consumption; and. 


72 MONEY 

as we shall now see, it also promotes inefficiency in pro¬ 
duction. 

Inflation, it is true, increases profits, and profits stimu¬ 
late industry: but the stimulus falls like the gentle rain 
from heaven on the just and the unjust — the producers 
who hinder as well as those who aid the winning of the 
war and the winning of the peace that follows. Further¬ 
more, the stimulus is only temporary. Although rising 
profits at first increase production, they also increase a 
discontent that soon interferes with production. The ob¬ 
ject of Government financing in the United States during 
the World War was necessarily to obtain more goods; 
and more were obtained as long as increased bank credit 
enabled employers to put idle people and idle machinery 
to work. The country soon reached the point, however, 
where it was employing virtually every man and every 
woman who was able and willing to work. After that, 
employers could add to their own staffs only by taking 
laborers away from other employers. At this point, com¬ 
petition among employers for workers inevitably resulted 
in higher wages and, consequently, in new demands on 
the banks for increased working capital. But bank credit 
created for the purpose of enabling somebody to take 
workers or orders away from somebody else did not in¬ 
crease production. There was no gain in the efficiency of 
the workers: on the contrary, the workers, already in¬ 
censed over what they called “war profiteering,” had less 
incentive to efficiency than ever, since they knew that, if 
they lost one job, they had only to go across the street 
to find another job. All this was clearly predicted by a 
number of economists early in the War. In 1917, Carl 
Snyder said: “Production, and therefore the actual vol¬ 
ume of exchanges, is practically at the limit and has been 
for a year or more. No expansion of bank credits can put 


MONEY AND INFLATION 


73 


this production any higher. It follows, therefore, as a 
practical fact that any expansion of bank loans now 
means inflation — to all practical intents, dollar for 
dollar.” 13 

Moreover, unusually high profits led to careless busi¬ 
ness methods; and excess profits taxes led to further ex¬ 
travagance, prompted by the thought that a large part 
of what might be saved would be taken by the Govern¬ 
ment in taxes. The net result of thus placing new pur¬ 
chasing power on the market without a corresponding in¬ 
crease in production was a further rise in prices, followed 
by further inflation, followed by further economic ineffi¬ 
ciency. Inflation in Great Britain led to similar results. 
“War-time production,” says C. H. Northcott, “carried 
on under conditions in which all economic checks and 
balances were removed, demoralized British manufac¬ 
tures. They became careless of prime and labor costs and 
of operating expenses. The excess profits tax completed 
the demoralization, causing them to invest unwisely in¬ 
stead of building up reserves. Inflated credit made 
their careless expenditure easier and currency inflation 
prompted reckless purchasing on the part of consum¬ 
ers.” 14 

All the apparent evidences of prosperity as prices rise 
— higher wages, higher profits, increased orders, more ex¬ 
tensive advertising, larger national income and expendi¬ 
ture — are gratifying only to people who overlook their 
monetary significance. There is no warrant for the com¬ 
mon belief that “a credit uplift of prices is a sign of nor¬ 
mal, healthy business conditions.” 15 When the whole 
situation is rightly diagnosed, these signs of apparent 
health are recognized as symptoms of an old disease. We 
may refrain from calling it inflation — that term recalls 
so many unhappy chapters in monetary history — but 



74 MONEY 

under any other name it brings the same unhappy results. 


Deflation is Equally Disastrous 

Wherever these results are felt, there arises a popular 
demand for deflation. The outcry is usually directed 
against “the high cost of living.” But there is not much 
choice between the remedy and the disease. Deflation 
does not reduce the real cost of living; but it does bring 
evils of its own — morally, socially, economically. Our 
muscles may be sore from climbing Pike’s Peak, but we 
gain little relief from climbing down, only some more sore 
muscles. Business, which feels the glow of unusual activ¬ 
ity as it rushes forward, looks very much dejected when 
it has to go back. It brings to mind the horse that ran 
away, much exhilarated by the exercise, but dropped 
dead at the stable door, after his master had forced 
him to run all the way home. Nevertheless, as business 
is now financed, a period of deflation is sure to follow a 
period of inflation; for, as we shall see in later chapters, 
bank deposits are extended and goods produced based 
on markets that turn out to be mirages. 

The usual results of deflation were experienced by 
Japan in the years immediately following the high-price 
peak of 1881. This typical experience is well described by 
the American consul. “Prices,” he says, “fell as precip¬ 
itately as they had risen. With this fall in prices, distress 
and desolation extended over the land, and millions of 
people who had supposed themselves on the high road to 
wealth suddenly found poverty staring them in the face, 
while exacting creditors on all sides demanded the liqui¬ 
dation of debt. Depression and a sense of adversity 
naturally followed; bankruptcies became common and 
misery was everywhere present.” 16 There was, in fact, 
a vicious spiral of deflation. 


MONEY AND INFLATION 


75 

Eagerness for higher wages is natural; but higher wages 
are no benefit to the people as a whole, when the cur¬ 
rency is inflated, and prices rise faster than wages. Eager¬ 
ness for lower prices is natural; but lower prices are no 
benefit to the people as a whole, when the currency is de¬ 
flated, and production is curtailed. For, no matter what 
happens to wages or to prices, people cannot buy any 
more than they produce. Here, again, we arrive at the 
most obvious and the most neglected of economic facts. 
It is the fundamental fact in the process of deflation. 
Figure I, which portrays the loss in production during 
periods of falling prices, shows at a glance why the 
people as a whole do not obtain as much to enjoy when 
prices are falling rapidly, as they obtain when prices 
are relatively stable. We must conclude, with Gustav 
Cassel, that a prolonged period of falling prices will 
never be accepted as a wise device of deliberate eco¬ 
nomic policy. 17 

Summary 

Inflation and deflation: neither of these monetary dis¬ 
eases is a cure for the other. Both are disastrous — mor¬ 
ally, socially, economically. The dominant economic need 
of the world is not “ abundant money,” not “ easy 
money,” not “a more elastic supply of money,” but a 
money that is a true standard of value. In an industrial 
order founded on private property, division of labor and 
competition, with its interest focused, as we have already 
observed, on the monetary aspects of nearly all its activ¬ 
ities, there is no economic phenomenon so far-reaching in 
its consequences as unstable money. A shifting price- 
level is sure to be accompanied by alternate periods of 
business elation and gloom, with the familiar trend of ex¬ 
travagance, injustice, excessive speculation, “ profiteer- 


MONEY 


76 

ing,” over-production, tight money, business failures, 
unemployment, and “hard times.” “All the power of a 
government,” says Herbert J. Davenport, “and all the 
skill of the agencies of credit control should be directed 
to the task of stabilizing the price system — the center 
and pivot and motor and regulator of all competitive 
activity.” This, let us repeat, is fundamentally a mon¬ 
etary task: there could be no shifting of price-levels under 
a barter economy, for there would be no such concept as 
price, no such thing as a price-level. How to prevent these 
extreme shifts of the price-level and extreme swings of the 
business cycle — the heights of prosperity and the depths 
of depression — is the economic problem. 


CHAPTER VI 

MONEY AND THE GOLD BASIS 

Early in the history of human intercourse, men began to 
use a medium of exchange. For this purpose they tried 
innumerable commodities, from primitive times when 
some use appears to have been made of shells and furs 
and cattle, down to recent times when certain hard- 
pressed farming communities in the United States tried 
to make corn legal tender. It is said, on meager evidence, 
that tobacco, salt, dried fish, eggs, iron spikes, and bullets 
have been used for media of exchange. However that 
may be, there is no doubt that many kinds of money 
have passed current, from time to time, and from place to 
place. As they varied widely in their fitness for the pur¬ 
pose, it was natural that in the struggle for existence the 
fittest should survive. 

There is no mystery connected with the fact that cows 
did not survive as currency. The Greeks, who in the 
Homeric poems expressed the value of coats of armor in 
terms of the number of kine they would bring in the open 
market, were well aware of the fact that cows, however 
admirable for certain purposes, were not all that could 
be desired as circulating media. In the first place, they 
were not easy for ladies to take with them when they 
went shopping. Nor were they readily divisible in mak¬ 
ing change, at least not without trouble to the traders 
and damage to the cows. Nor were they durable: before 
the owner could spend them, they might lose weight or 
die. Furthermore, no two cows were exactly alike or of 
exactly the same value: as a result, arguments were al- 


MONEY 


,? 8 

ways in order not merely concerning the value of the 
goods offered for sale, but likewise concerning the value of 
the medium of exchange. In short, cows were destined 
to escape the arduous work done by money — which 
Bassanio centuries afterward dubbed ‘‘the pale and com¬ 
mon drudge ’tween man and man” — because they did 
not possess those traits of a satisfactory currency which 
are now discussed in the textbooks as portability, divisi¬ 
bility, durability, homogeneity, and uniformity. 

There is still another essential attribute of money — 
termed by Jevons “cognizability ”—that helps to ex¬ 
plain why gold survived. 1 It is easy to recognize a piece 
of gold. It is easy, for that matter, to recognize a cow; 
but an acceptable currency must satisfy all the tests, and 
men have discovered, first in one part of the world and 
then in another, that no single commodity possesses all 
the essential qualities in so high a degree as gold. No 
other commodity, having the other needed characteris¬ 
tics, is so easily carried about as gold: most of us could 
carry in our pockets, in the form of gold coins, all the 
money we could afford to spend in a day, without being 
aware of the weight. No other commodity, equally good 
in other respects, is also both infinitely divisible and vir¬ 
tually indestructible. If a gold coin had been placed in 
circulation in the boyhood days of Methuselah, and had 
since been subjected only to the ordinary uses of cur¬ 
rency, it would be much worn, no doubt, but still a gold 
coin. 

The Monetary Basis must be universally desired 

% 

But we have not yet told the whole story. Paper 
money can be made that is sufficiently durable, that is 
more easily carried about than either gold or silver, and 
that is just as satisfactory in respect to all the other qual- 


MONEY AND THE GOLD BASIS 


79 


ities we have enumerated. Until comparatively recent 
times, however, paper money did not meet the needs of 
trade because there was no assurance that it would be 
generally accepted. Something was needed which was 
widely desired on its own account — which did not de¬ 
pend for its value solely upon somebody’s keeping a 
promise to give something else in exchange for it. Gold 
met this test because it was in universal demand for pur¬ 
poses of decoration and for other uses in the arts. Silver, 
since it also met this test, as well as all the others that 
we have mentioned, long disputed with gold the right to 
be the “ standard of value,” or at least to have its part 
in a “ bimetallic standard.” This controversy, although 
prominent in the history of currency, can throw little 
light on current commercial problems. In any event, the 
question was settled long ago: whether or not silver might 
have been adopted universally as the basis of money, the 
fact remains that it was not adopted. In some countries 
gold is still valued as highly for ornament as for money. A 
debutante in India joyously carries on her person thirty 
pounds of gold trimmings, with the reckless disregard for 
comfort that is shown by her fur-bearing sister on a warm 
day at Atlantic City. In most countries, however, the 
present demand for gold in the arts depends in part upon 
the fact that it is used as the basis of money. The greater 
the demand for gold as a medium of exchange, the more it 
was desired in the arts: its prestige as money enhanced its 
value as ornament. 

All these requisites of a medium of exchange — porta¬ 
bility, divisibility, durability, homogeneity, uniformity, 
cognizability, and intrinsic value — although still dealt 
with at length in books on money, are no longer live is¬ 
sues. If we needed nothing more to aid us in carrying on 
the work of the world than to find a medium of exchange 


8o 


MONEY 


that satisfied all these tests, the problem would now be 
settled for most nations by the adoption of gold — 
settled on better grounds, evidently, than “a sentimental 
preference.” Indeed, it would be settled in such a satis¬ 
factory manner that for most people the subject would 
have merely an historical interest. It would create no 
more controversy than the use of steel in rails. 

A Satisfactory Basis has Stability of Value 

However, to be beyond reproach as money, a commod¬ 
ity must have still another quality, and one that is far 
more difficult to find: it must have a high degree of sta¬ 
bility of value. Now gold, as we have observed in the 
preceding chapters, is not free from wide fluctuations in 
exchange value. That is one reason why the problem of a 
stable monetary unit, even in the only countries which are 
still on a gold basis, is a major interest — perhaps the 
paramount interest — of business. But having admitted 
that gold is not absolutely stable in purchasing power 
— a point to which we shall return presently — let us 
take due account of the fact that no other basis in recent 
times has been as effective as gold in curbing fluctuations 
in the purchasing power of money. 

Most of the real evils attributed to the gold basis are 
the evils of unstable money; and they are evils whether 
money is unstable on a gold basis or on any other basis. 
But, as a matter of historical fact, as well established as 
the multiplication table, the purchasing power of money 
in recent times has fluctuated less in gold-basis countries 
than in any others. Says the Ford Weekly: “A pound of 
French silk, or a gallon of Italian olive oil, or a dozen 
German knives are units of wealth the world over, as is 
the bushel of American flour, subject in each case to the 
immutable law of supply and demand. If given quanti- 


MONEY AND THE GOLD BASIS 


81 


ties of these articles were traded in on the basis of ancient 
barter, each trader would receive an adequate value in 
exchange. As soon, however, as the modern method of 
finance on the gold basis requires that each article must 
first be reduced into terms of gold, values are dislocated, 
and the goldless trader is penalized accordingly.” 2 On 
the contrary, it is in barter trading that the exchange 
values of goods are most uncertain. This is partly be¬ 
cause the inconvenience of barter greatly restricts the 
markets, whereas it is free and wide markets that tend to 
stabilize values. Indeed, barter trading could develop no 
“market price” at all. 

Like “Coin’s Financial School” and the Bryan cam¬ 
paigners of old, the reformers of to-day attribute business 
depressions to the gold standard. “Goldless Germany,” 
they say, “is humming, busy, productive. Gilded United 
States is stagnant, timid, lopsided. The two peoples 
represent, individually, almost identical industrial units. 
This conclusively shows that there can be nothing wrong 
with the American people themselves. Consequently, 
something else must be wrong. And that something is the 
gold standard.” 3 But this argument does not explain 
how it happened that a few years ago Germany and the 
United States, both on the “gold standard,” were the 
busiest and most productive countries in the world; and 
how it happens that to-day Russia and Austria, the two 
great nations that have wandered farthest from the “gold 
standard,” are the most stagnant and unproductive of 
all. “In the United States,” it is said, “business is at a 
standstill almost everywhere, labor is idle, and the pro¬ 
ductiveness of more genuine capital has been suspended, 
because every commodity must be reduced to a gold unit 
of value before it can attain the privilege of exchange¬ 
ability with some other American commodity.” 4 The 


82 


MONEY 


fact is that the gold basis, of and by itself, neither causes 
nor prevents either booms or depressions. * 

Gold Reserves are used to maintain Convertibility 

Gold helps to meet the financial requirements within a 
country in two ways: first, as currency, and, second, as 
reserves. When a country is on a gold basis, the amount 
of gold needed for currency, and the amount of gold coins 
which in consequence the banks must carry as till money, 
depend on the volume of business, the habits of the peo¬ 
ple, and the degree of their confidence in the ability of 
the country to maintain the circulation of paper dollars 
on a par with gold dollars. In many European countries 
during the World War this confidence vanished. In the 
United States, on the other hand, gold all but disappeared 
as a medium of exchange, not because there was a pre¬ 
mium on gold, but because most people preferred paper 
money and bank checks. The people adjusted them¬ 
selves to this change readily and with little protest, even 
on the Pacific Coast where before the World War gold 
coins were more generally used than bank notes. The 
people did not insist on exchanging their paper for gold, 
even when the banks deliberately put difficulties in the 
way of free convertibility — not because the people be¬ 
lieved in the ability of the country to maintain the cir¬ 
culation of paper dollars on a par with gold dollars, but 
because, on account of this belief among the few people 
who did any thinking at all on the subject, all forms of 
paper money actually did circulate on a par with gold. 

Some reformers insist that the reason why the people 
are satisfied to be on a gold basis despite the difficulty of 
obtaining gold on demand “is due to the impression, con¬ 
stantly fanned among the masses, that the ‘ money’ they 
handle is as good as gold.” 5 This statement is an error. 


MONEY AND THE GOLD BASIS 


83 


People do not accept paper money because they think it 
is convertible into gold. They accept it because their 
daily experience has convinced them that other people 
will freely accept it. If, with money on any other basis, 
they had the same daily experience, year in and year out, 
they would continue to accept the money and continue 
to think nothing about its basis. But that is a large “if.” 
Every country that has abandoned the gold basis has 
found it impossible to maintain the belief among its peo¬ 
ple that its fiat money would be accepted as though it 
were “as good as gold.” The use of gold reserves to jus¬ 
tify this belief is the second monetary function of gold. 

To justify this belief, no country is obliged to keep on 
hand enough gold to satisfy all the claims of all the people 
who, as holders of various kinds of paper money, have 
a legal or customary right to demand gold. No country 
that is on an assured, convertible basis needs such vast 
reserves. In the United States, for example, there is an 
immense inverted pyramid: at the bottom, a compara¬ 
tively small volume of gold; based on this gold, a larger 
volume of paper money; and, on top of all that, an 
even larger volume of bank credit. To keep all these 
paper promises on a par with gold, only enough bullion is 
needed to meet actual, legal demands for gold. We know 
from experience that the maximum demand for conver¬ 
sion that is theoretically possible will never actually be 
made, just as we know from experience that it would be 
an inexcusable waste to provide for the theoretically 
possible, maximum demand on an electric power plant. 

“Before the War,” says Mr. Edison, “German cur¬ 
rency was on a gold basis; to-day she has many millions 
of gold in the Reichsbank. Isn’t she still on a gold basis? 
If not, at what particular state of her holding of gold did 
she cease to be on a gold basis? ” 6 The answer is clear and 


MONEY 


84 

simple. When a country is on a gold basis, it meets its 
obligations in gold, dollar for dollar, as far as it is called 
upon to do so. The moment it fails to do so, it is off the 
gold basis. 

Rarely are there any runs on the banks of the United 
States, although it is well known that even in this country, 
which has such a large proportion of the world’s mone¬ 
tary gold supplies, there is not enough gold to meet all 
the legal demands that, theoretically, might be made. 
But because there is not a dollar of gold behind every 
dollar of money in circulation, the country is bombarded 
with denunciations of “fake bank notes,” “imaginary 
money,” “fraudulent standards.” “The deception,” it 
is said, “bleeds the common people for the enrichment of 
the gold barons .” 7 And so shock troops, supplied with 
large munitions of gold-supported money, are dispatched 
to destroy the gold standard. It can hardly be called a 
“deception,” however, when every day the United States 
Treasury publishes the exact figures for gold bullion, 
gold coin, Federal Reserve bank notes, silver coins, and 
every other form of money. Furthermore, the so-called 
deception injures nobody except the “gold barons” 
themselves, if by that term is meant the owners of gold 
and gold mines; and they lose merely because, if there 
were no superstructure of bank credit and paper money 
on the gold basis, gold would be more valuable than it is 
to-day. If the “gold barons” have been dictating mone¬ 
tary policies during the past generation, they have sacri¬ 
ficed their own financial interests, for gold has fallen in 
value. But perhaps we may assume, after all, that some 
opponents of the “gold standard” are not so concerned 
as their words imply over what they call the inadequacy 
of the gold reserves, since they themselves urge the abo¬ 
lition of all gold reserves. 


MONEY AND THE GOLD BASIS 


85 

Except in times of crises, we do not know how large the 
reserves must be to insure convertibility. We do know 
that during the World War the nations of Europe in their 
attempts to maintain an adequate gold reserve encoun¬ 
tered difficulties which seemed to them insurmountable. 
From the beginning of the War to 1921, the ratio of gold 
to note issues fell in England from 118 to 29 per cent, in 
France from 61 to 14 per cent, in Germany from 45 to 1 
per cent; and in some other countries the gold all but 
vanished. The so-called convertible notes of these coun¬ 
tries were merely fair-weather notes. They were ex¬ 
changeable for gold only when the demand for conver¬ 
sion fell within the usual, narrow limits of quiet times. 
It is only in a hurricane, however, that a ship’s anchor is 
fully tested; and it sometimes takes a world war to dem¬ 
onstrate whether a country’s gold anchor is sufficient to 
keep it from drifting away upon multitudinous seas of 
inconvertible paper. 

To maintain Convertibility, Gold Reserves must be used freely 

To maintain the confidence of the people, gold re¬ 
serves must be used in time of stress freely and boldly. 
That is precisely what they are for. To try to protect 
them when a panic threatens would be like sealing up the 
fire-extinguishers whenever an alarm sounded. Misers 
have been found starving in the midst of hoards of gold: 
banks could fail with their tills full of money. The Boston 
Five Cent Savings Bank showed a clear understanding of 
human nature and of the right use of its reserves. When a 
run started, the Bank paid out money as rapidly as pos¬ 
sible. It declined to take advantage of the sixty days’ 
notice legally required of depositors; it employed addi¬ 
tional paying tellers at once and kept open additional 
hours. Naturally, the easier it was to get money out of 


86 


MONEY 


the bank, the more contented the depositors were to 
leave it there. The run was soon over. 

It may be worth while to note, in passing, that savings 
banks would be stronger and could operate safely on 
lower reserves if they were compelled, in times of stress, 
to take advantage of the law that requires depositors to 
give sixty days’ notice of withdrawals. For some banks 
that could meet all demands within sixty days could not 
do so at once. Because it is their business to lend money, 
and because they could do business in no other way, it is 
impossible for either commercial banks or savings banks 
to meet all their obligations at any one time. This fact 
should be a matter of common knowledge. The public 
should no longer be encouraged to count on the right to 
withdraw their deposits without notice. As long as the 
option is left, as at present, with the individual bank, the 
bank has no option at all: it must pass out money with a 
lavish hand. Confidence must be maintained at all costs. 

All this is contrary to the popular notion that the banks 
hoard money in order to limit the amount in circula¬ 
tion for their own profit. Says the Better Banking Bu¬ 
reau, “ It is to the interest of those in control of the banks 
to contract the medium of exchange.” Says the Palla¬ 
dium: “Only a very little of the money the Government 
makes is allowed by the banks to get to the people, 
[the banks] preferring that the people be dependent on 
bank credit.” 8 According to the Dearborn Independent , 
“Banks hoard money for the same reasons that monop¬ 
olies restrict production — to be able to secure greater 
profits on their stock in trade.” 9 H. L. Loucks, spokes¬ 
man for another group of reformers, says that “what we 
have left of gold coin and lawful money is being rapidly 
hoarded in the bankers’ vaults.” 10 These ideas are er¬ 
roneous, in the first place, because banks lose rather than 


MONEY AND THE GOLD BASIS 


87 

gain when the currency is deflated. In the second place, 
the people, for the most part, determine how much money 
is handed over to the keeping of the banks: without de¬ 
positors, most of the banks would close their doors. In 
the third place, the people and not the banks decide the 
relative amounts of “lawful money” and of bank credit 
that are used in daily exchange. When a bank makes 
a loan of a thousand dollars to a farmer, or to a stock 
broker, or to anybody else, the one who receives the loan 
is free to draw out all or nearly all the money in gold, 
or to draw it out in bank notes, or to transfer the credit 
to other persons by writing checks, or to leave it in the 
bank. Or he may use any part of the loan in one way and 
any other part in any other way. Even though an indi¬ 
vidual bank may make restrictions concerning the form in 
which a loan shall be used, the borrower may draw checks 
which are promptly deposited in other banks where there 
are no such restrictions. And so it is the choices made by 
all the bank depositors every day that determine how 
much of “the money the Government makes” gets into 
circulation. The banks find out, from demands made 
upon them, how many dollars of bank notes and of small 
coins the people use for every dollar of bank credit. The 
people can easily change that ratio whenever they please. 
For all these reasons, it is absurd to charge the banks 
with hoarding currency or curbing the expansion of bank 
credit in order that they may profit by a scarcity of 
money. 

Arbitrary Restraint is needed upon Issues of Paper Money 

The chief purpose of the gold reserve is to prevent de¬ 
preciation of paper money by adequately providing for 
its convertibility into gold. This object can be achieved 
only by limitation of the volume of paper money. But 


88 


MONEY 


once the process of inflation is well under way, any limi¬ 
tation, whatever, causes what is called "scarcity of 
money.” After Germany had increased its issues of paper 
marks more than one thousand fold, merchants were 
still complaining that there was "not enough money to 
do business with.” In Russia, where so many trillions of 
rubles were issued every day that the cost of living, ac¬ 
cording to an official estimate, became 257,000 times the 
pre-war cost, and where the financial performances of the 
Government took on the aspects of a comic opera, busi¬ 
ness was still impeded by a "dearth of currency.” This 
is not surprising. As there are always people who are sure 
that they would be better off if they had more "ready 
cash,” campaigns for freedom from the restraints of the 
gold basis occur in every country as regularly as the 
movements of the business cycle. 

I Particularly in times of depression, when currency 
seems unusually scarce, governments are urged to issue 
"fiat” money — that is to say, money which is supposed 
to be just as good as any other money merely because 
governments say so. Such was the Continental money of 
Revolutionary days in the United States, which the Gov¬ 
ernment insisted was perfectly good money even after it 
had become nearly valueless. Such were the irredeem¬ 
able "greenbacks” which were favored in the seventies by 
a business man so eminently successful as Peter Cooper. 
Such would be the "Muscle Shoals Greenbacks,” if 
issued according to the plan advocated by men so ex¬ 
traordinarily able, in their own special fields, as Mr. Ford 
and Mr. Edison. 

Mr. Ford proposed to take over and develop the power 
plant at Muscle Shoals, Alabama, provided the Govern¬ 
ment would complete the plant. The thirty millions of 
dollars which seemed necessary for this work, Mr. Ford 


MONEY AND THE GOLD BASIS 


89 

declared could be obtained from the printing-presses 
at little cost to the Government. Mr. Ford was right if 
only initial costs are considered; but he was wrong if he 
thought that he had discovered anything new in methods 
of finance. The history of finance, at least, is not “all 
bunk.” The same plan was carried out in the days of 
American wild-cat money, until the time came when a 
Mississippi steamboat captain who asked the price of 
firewood received the answer, “Cord for cord.” Exactly 
the same reliance on printer’s ink brought Russian cur¬ 
rency after the World War to the point where it took a 
bale of one ruble notes to buy a poor hat. Indeed, it was 
Mr. Ford’s proposal, carried out logically in central and 
eastern Europe, that did even more than the War to 
demoralize the industry and trade of the world. We say 
“carried out logically,” for if the printing-press is all we 
need for thirty millions of dollars, why not thirty billions? 
If one plant is a sufficient basis for currency, why not 
a thousand plants? If the Government should print 
money to assist the projects of one citizen, why not all 
citizens? And with such boundless issues of paper dol¬ 
lars, how would our own currency differ from that of 
Russia? Eventually, it would differ not at all. Indeed, it 
is the Lenin-Trotsky policy of paying bills with the 
printing-press — a method first employed, according to 
Goethe’s Faust , by the Devil — that, in various forms, 
is now being urged upon the United States. 

It is true that money issued against anything of value 
might circulate at par with gold certificates, with or 
without the fiat of the Government, provided the volume 
of notes were not too large. Modern champions of fiat 
money appear to have mistaken the reason why a silver 
dollar buys as much as any other dollar. It is not be¬ 
cause the Government says the coin is worth a dollar, 


90 


MONEY 


nor because the silver has some value, but because the 
Government limits the number of coins. If too many 
silver dollars were placed in circulation, the Govern¬ 
ment might declare them to be equal to gold dollars, and 
require everybody to accept them at their face value on 
penalty of death, and they would still be depreciated 
dollars. Since the bullion in a silver dollar is worth less 
than one hundred cents, it has nothing whatever to do 
with keeping silver dollars on a par with gold dollars; and 
the silver reserves in the Treasury vaults are of no mone¬ 
tary use whatever. They represent a Government sub¬ 
sidy to owners of silver mines. They are maintained in 
adherence to a policy that has no more to commend it 
than would the subsidizing of the shipping industry by 
the purchase of ships that are never to leave port. Thirty 
millions of dollars, “representing” the Muscle Shoals 
project, or Hood River apple ranches, or nothing at all, 
would not debauch the currency if the issues stopped 
there. Such an able business man as Mr. Ford could 
probably stop short of a currency debauch, by making 
the Muscle Shoals plant yield products that could be sold 
for sufficient money to retire the original issues of notes: 
but we could hardly expect Congress to stop with one 
project. When, however, Congress has to borrow money 
instead of printing it, automatic stops are provided. 

Various other monetary matters are badly confused in 
the Muscle Shoals project — the meaning of interest, the 
distinction between money and capital, the theory of 
bank credit, the factors that change the purchasing 
power of money — subjects which cannot be dealt with 
at this point. But we ought not to leave this discussion 
without a passing reference to two of the substitutes for 
the gold basis which have been urged most persistently: 
labor-hours and land. 


MONEY AND THE GOLD BASIS 


9i 


Labor-Hour Units are Impracticable 

The labor-hour as a unit of exchange and a substitute 
for gold has been proposed many, many times in the past, 
has been tried recently in Russia, and is now enthusiasti¬ 
cally advocated by the Equitist Society. The argument 
is that all wealth is the product of labor; that labor should 
therefore be the basis of money; and that, as a matter of 
justice, every man should be able to exchange the prod¬ 
uct of his labor for the product of the same amount of la¬ 
bor of any other man. Accordingly, it is proposed that 
every worker should receive one exchange-unit for every 
hour he works, and that the price of each commodity 
should be as many exchange-units as it took hours to 
produce it. Thus, if it took a hatter three hours to make 
a hat, he would receive for his labor three exchange- 
units, and they would entitle him to a book that was 
made in three hours. The evident purpose of the plan, to 
do justice to all workers and insure an equitable distri¬ 
bution of all the products of labor, should commend itself 
to all people. 

The difficulties, however, of carrying out the labor- 
hour plan are insuperable. In the first place, by what 
means are we to determine how many hours it took to 
produce a given article? Consider, for example, a copy of 
the latest novel. How long did it take to make the ink, 
dies, glue, and thread used in the book? How much of the 
labor of the author, advertiser, and bookseller are to be 
charged to this copy of the book? How much of the time 
of the fireman who stoked the engine that hauled the car 
that carried the pulp that went to the mill that made the 
paper the book used? We need go no further to show the 
impossibility of pricing the book on a labor-hour basis, 
though we should have to go much further before we had 


92 


MONEY 


found all the miners, stenographers, bank clerks, freight 
agents, postmen, fishermen, salesmen, and so on, whose 
labor helped to produce that book and to place it in the 
hands of the man who bought it. In the second place, 
what is to be done with all the products that nobody will 
buy at the fixed price — the books that nobody wants, 
the cakes that were spoiled in the making, the hats that 
are out of style? How, on the other hand, are goods to 
be distributed when the demand, at the labor-hour price, 
exceeds the supply? Which lovers of art are to have the 
privilege of exchanging their labor, hour for hour, for the 
labor of our greatest portrait painter? Somebody must 
decide: the artist could not honor the labor-hour checks 
of all the eager patrons of art who had the right to 
present them. 

There is a third objection: under a plan by which 
every man’s wages are the same regardless of the work 
he performs, where are we to get our ditch diggers, our 
telephone operators, our heads of great industrial enter¬ 
prises? Why should any one choose the hard or the dis¬ 
agreeable jobs? The fourth objection is also the insuper¬ 
able objection to Communism. The longer a man took to 
make a hat, the more labor-hour checks he would receive 
for making it. Efficiency would soon become an historic 
virtue. Few workers would find adequate incentives to do 
their best in any position if rewards bore no relation to 
achievements. The whole world would suffer, therefore, 
because of decreased output. Finally, the labor-hour 
unit would be more disastrously unstable in value than 
cows, or nails, or hides. This extensive examination of 
labor-hour units is unnecessary, perhaps, for the purpose 
of showing the futility of the plan; but it may help to 
make vivid the infinitely complex work which monetary 
units on a gold basis now perform daily with almost 
incredible smoothness. 11 



MONEY AND THE GOLD BASIS 


93 


Land, as a Basis of Money, cannot stabilize its Value 

Now others are advancing the equally alluring, equally 
old, and equally unsound proposal that money should be 
issued “representing” farm lands. Why not? “Our need 
is more money,” they say, “and we must take another 
step in the evolution of our medium of exchange and base 
the increased supply on the best security in the world — 
productive land. . . . We can no more have too much of 
the representatives of wealth than we can have too much 
wealth.” 12 This idea makes a strong appeal to many 
farming communities. Why not eliminate banks? If a 
farmer needs money to buy land, or even to buy plows 
and seeds for the land he already owns, why should he 
either stop planting or be obliged to pay interest on a 
loan? Why should not the Government issue new cur¬ 
rency, based on the land? Then the laborer would have 
the needed money, production would go forward, and 
nobody would make profits merely by lending money — 
which, after all, it is the sole privilege of the Government 
to issue. This is the most attractive form in which the 
land-basis argument can be presented. It sounds plaus¬ 
ible. It has always sounded plausible. 

It seemed entirely plausible to the French people at 
the time of the Revolution. They issued money which 
“represented” property. They called the new money 
assignats , because the notes were supposed to be as¬ 
signments of public land. At first 7000 millions were 
issued; then 10,000 millions; a few months later, 16,000 
millions; and, by the end of the year 1795, 45,000 millions. 
In an attempt to maintain the value of this land-basis 
currency, the law declared that any one who gave or 
accepted it at less than face value should spend twenty 
years in irons. In spite of the law, the assignats depreci- 


94 


MONEY 


ated until the holder of a note professing to be worth as 
much as five United States dollars was lucky if he could 
pass it off for as much as two cents. It is not true that, 
because the country was bankrupt, France “ would have 
been worse off without assignats than with them.” 13 
Printer’s ink aggravates rather than alleviates the mal¬ 
ady of bankruptcy. Massachusetts also found this out 
when, in colonial days, it issued land-currency. Unmind¬ 
ful of these experiments, Japan, in 1868, issued forty- 
nine million yen on the “security of land.” The usual 
depreciation in value and the usual fruitless efforts of the 
Government to stop it by law followed promptly. 

Thus, land as a basis for money has always failed to 
stabilize its purchasing power. The reason is simple. As 
soon as we issue money against land, we increase our 
money but not our land. Therefore, money depreciates 
in purchasing power and land appreciates in dollar-value. 
Consequently, land has a higher loan-value and for this 
reason can serve as the basis for even larger issues of 
money than before. But these new issues still further en¬ 
hance the dollar-values of land, so that it can serve as the 
basis for still further issues of new money. And so on, 
without limit. This is the vicious spiral of inflation. That 
is why land cannot stabilize money. A ship is not held in 
place merely because it is made fast to another ship which 
is itself drifting. In short, whenever we use land as the 
basis of new money, the dollar-value of the basis itself 
increases with the increased volume and consequent de¬ 
preciation of the money. Then we can issue more dollars 
on the same basis, with the same result, and so on. Thus, 
land provides eventually for issues of paper money as 
boundless as Russian rubles. 

Nevertheless, people are still insisting that money 
cannot depreciate if it “represents” land. Every little 


MONEY AND THE GOLD BASIS 


95 


while a bill comes before Congress which provides for the 
issue of paper money up to a certain per cent of the value 
of any farm lands upon which the owner wants to borrow 
money. In disregard of the lessons of history, Senator 
Ladd has introduced a bill which authorizes unlimited 
issues of paper money based on land, with the futile 
proviso attached that “any discrimination in favor of 
gold against the lawful money of the United States, or 
any combination in restraint of the free and unobstructed 
circulation of the lawful money of the United States 
should be a criminal conspiracy against the Government 
and punished by imprisonment for not less than ten 
years.” 14 

This brings us back to the efficacy of gold as a restraint 
on the universal tendency toward inflation. The whole 
world knows exactly what is meant by the convertibility 
of a paper dollar into a fixed weight of gold. But what is 
meant by the convertibility of a paper dollar into land? 
What is meant by a unit of land? Where could the holder 
of money get it, and what could he do with it? Who 
would accept it in exchange? How could it be sent across 
the ocean to settle international balances? Nobody 
questions the value of land for certain purposes, but for 
monetary purposes it is more cumbersome than cows. 15 

Conclusion 

Many earnest and high-minded reformers, convinced 
that our economic system does not function as it should, 
are impatient with a defense of any part of the system. 
They seem to take the position that because something is 
wrong, everything is wrong; that because change is the 
law of progress, any change must be progress. To them 
a defense of the gold basis seems reactionary and there¬ 
fore bad. We must agree that it is hopelessly unpro- 


96 


MONEY 


gressive to insist that everything is all right when period¬ 
ically we have surplus raw products, idle factories, idle 
workers, idle dollars, and no way of getting the materials, 
machines, men, and money into such relations that they 
can go on with the work of feeding and clothing humanity. 
We do not need the perspective of a man from Mars to see 
that something is wrong. But when there is a hot-box, 
we cannot set the machinery in motion by seizing ham- l 
mers and pounding the engine in the wrong place. Not 
only is valuable time thus wasted, attention diverted 
from the right place, and the machinery injured, but 
meanwhile the bungling mechanics work themselves into 
such bad temper that there is less prospect than ever of 
eliminating the real troubles. To attack the gold basis 
of money is to hammer the economic machinery in the 
wrong place. 


CHAPTER VII 

MONEY AND THE COMMODITY BASIS 

As a basis for money, there is much more to be said in 
favor of commodities than in favor of land or labor-hours. 
And much has been said, especially by Henry Ford and 
Thomas A. Edison. These are names to conjure with! 
They appeal to the imagination, for both men are re¬ 
sourceful, inventive, Aladdin-like in their achievements. 
Their proposals on any subject are received with interest. 
Little wonder, then, that when they turn to money — a 
subject that touches human interests more frequently 
than any other — their ideas are heralded with loud ac¬ 
claim. It is fortunate that such men are trying to find 
out the meaning of money and directing public attention 
to the subject. For some day we may contrive to make 
money better serve its purpose; but we are not likely to 
achieve a better system, or to retain it when achieved, 
unless we also achieve a widespread understanding of 
the ways in which money to-day helps and hinders the 
work of the world. Without such an understanding, we 
can never be quite free from the danger of following 
European countries into economic chaos. 

The particular proposals of Mr. Ford and Mr. Edison 
may seem of ephemeral interest: probably they will soon 
be forgotten. But error, crushed to earth, will rise again. 
In the next generation, no doubt, similar proposals will 
be presented, with all the enthusiasm of a new discovery, 
by some wizard of science who, because of his conquests 
in totally different fields, will be accepted by the public 
as an authority on finance. 



98 


MONEY 


Both Mr. Edison and Mr. Ford are not only distrust¬ 
ful of the gold basis, and distressed over the shifting 
dollar, but eager “to divorce agriculture from the bank¬ 
ing system,” to aid farmers in obtaining loans easily, and 
to abolish speculation in farm products. All these ends 
they believe can be achieved by means of what they call 
commodity money. In these aims, we should all be in¬ 
terested, for the farmer’s problems are real, he has not 
in recent years obtained what he deserves for his labor, 
and the rest of us cannot prosper as we should unless 
the farmer prospers, too. 

The Edison Commodity Money Plan 

Under the Edison plan, 1 we have concrete warehouses, 
in charge of Federal officers, built and owned by the 
Government. The money to build the warehouses is 
raised by taxation. To these warehouses the farmer 
brings any basic commodities — cotton, wheat, rice, to¬ 
bacco, for example — that have been raised on American 
soil, and upon which he wishes to borrow money. Let us 
suppose that he brings cotton to the Federal warehouse 
at New Orleans. The Government agent at New Orleans 
grades his cotton and hands him two pieces of paper: a 
mortgage certificate and an equity certificate. 

The mortgage certificate the farmer exchanges at any 
national bank for Federal Reserve notes up to fifty per 
cent of the average value, for the previous twenty-five 
years, of the goods he has thus mortgaged. In this way, 
the farmer obtains a loan of money without incurring any 
expense for the use of the money. And he still owns the 
cotton. 

His equity certificate is his evidence of ownership. It 
is like a pawn ticket. He, or any one to whom he sells the 
certificate, can present it at any time within a year, to- 


MONEY AND THE COMMODITY BASIS 


99 


gether with the exact amount of money that has been 
loaned on the cotton, and receive the cotton. Thus the 
transaction is closed. Or, instead of retaining the equity 
certificate or selling it outright, the farmer may present 
it at a bank as security for a loan. 

If the cotton is not removed within one year, the Gov¬ 
ernment must sell it and thus get back the money it has 
loaned. This is to prevent an accumulation of goods and 
to make sure that the money will be self-cancelling. As 
soon as the farmer repays the loan or the Government 
sells the cotton, an amount of money equal to that ad¬ 
vanced on the mortgage certificate is destroyed. Is there 
to be an additional gold reserve to support the additional 
Federal Reserve notes issued under the Edison plan? 
We assume not, for the plan embodies no means of pro¬ 
viding additional gold or of changing the present re¬ 
serve requirements. This, in all essentials, is the Edison 
Commodity Money plan. 

It involves Further Government Control of Industry 

Its specific aims and methods deserve consideration, 
one by one. But, before coming to a detailed examina¬ 
tion of the plan, most men will be impressed by the fact 
that it involves additional taxes, additional corps of 
political appointees, and a vast extension of Govern¬ 
ment control over industry. Consider merely the most 
obvious of the political aspects. If the special privilege of 
borrowing money without interest is really a boon and is 
granted only to certain groups of producers, the list to be 
changed from time to time as the experiment proceeds, 
somebody must decide who are to be the specially fav¬ 
ored groups. And whether that somebody is Congress or 
Federal warehouse directors who are subject to partisan 
appointment and removal, the question who is to receive 


> * 
» ) t> 



100 


MONEY 


“free” money remains in politics, and becomes most ur¬ 
gent as election day approaches. 

Subject also to the regulation of Government officers 
would be the throwing upon the markets of unclaimed 
commodities in Federal custody, which might become 
necessary in times of depression; and the experience of 
the Government, in trying to sell surplus war supplies, 
leaves no doubt that great political pressure would be 
brought to bear to prevent the custodians of mortgaged 
farm products from offering them in the markets when¬ 
ever such offerings would affect prices — which is at all 
times. Furthermore, it would take an army of Govern¬ 
ment officers to determine exactly which sacks of sugar, 
and cotton, and wool, for example, were grown on Amer¬ 
ican soil, and which ones had previously been used as 
security for Government loans. 2 As a rule, nobody could 
tell, merely by inspecting the products, where they orig¬ 
inated, or how many times they had been stored and 
withdrawn. Yet the Government would have to tell in 
order to prevent accumulation of commodities. Other 
political complications will occur to any one who tries to 
figure out exactly how the plan could possibly be put into 
effect. 

Most men, therefore, no matter how heartily they may 
approve the purposes of the plan, will look upon its polit¬ 
ical aspects as an initial cause for concern. During the 
World War, Government regulation of business was con¬ 
sidered a necessary evil, to be tolerated, in spite of its 
waste and bungling and injustice, because the peace¬ 
time organization of industry is not adapted to the busi¬ 
ness of waging war. Great economic loss was inevitable. 
But every one, except some of those who, at the expense 
of the others, profited by Federal control, looked for¬ 
ward eagerly to the resumption of private management. 



* < 
< < * 




MONEY AND THE COMMODITY BASIS ioi 


There were few men in any branch of production or dis¬ 
tribution who did not either gain unfairly or lose un¬ 
fairly because of Government activities. And, as the War 
piled up further evidence of the inefficiency of the Gov¬ 
ernment in the management of business, the demand 
arose, from coast to coast, formless government in busi¬ 
ness, and more business in government.” There is no 
gainsaying the fact that there is a presumption against 
any plan that sets up new, permanent staffs of Federal 
officers and further Government regulation of industry. 

Is Commodity Money sounder than Gold Money ? 

This mere presumption against the plan, however, 
should not stand in the way of a careful study of its in¬ 
dividual aims. Mr. Edison contends, first of all, that his 
commodity dollars will be sounder than gold dollars be¬ 
cause “there in the warehouse, in the Government’s cus¬ 
tody, lies the actual wealth, the things we eat and wear 
and must consume to live, not in the minus ratio of one 
to two, as gold may be held to money, but in the plus 
ratio of two to one.” 1 At first, he says, only a few basic 
commodities are to be accepted, such as grain, cotton, 
wool, rice, legumes, fats, flax, and tobacco. Manufac¬ 
tured articles will not do: great care must be taken in 
selecting the goods upon which new money is to be is¬ 
sued. 

Now, if the specific commodity against which money is 
issued means anything at all to the holders of the money, 
it must mean that the money is redeemable in that com¬ 
modity. For what comfort would it give to the owners 
of paper dollars issued against wheat to know that the 
wheat was safely stored somewhere, if they had no claim 
against it? There is still great wealth in Russia, but a 
paper ruble is next to worthless because it is not a legal 



102 


MONEY 


claim on a specific weight of gold, or a specific weight 
of anything else. That money represents wealth is not 
enough; but many reformers mean nothing more than 
that when they say that money should be “ based" on 
commodities. 

Since the World War, new enthusiasm has been aroused 
over the old proposal that currency should be issued on 
the security of “property of all forms” — that every¬ 
body should have a right to demand that money be 
issued representing anything of value he happens to 
possess. In 1921, H. C. Cutting maintained, in The 
Strangle Hold , that “commerce has now outgrown credit 
based on one commodity, and requires a system of 
credit based on all commodities of value.” 3 Free coinage 
of silver was rejected: now the demand comes for free 
coinage of turnips and tripe and everything else. In 1922, 
C. J. Melrose issued a volume on Money and Credit to 
prove that we should abandon the gold basis and substi¬ 
tute “a currency of which every unit stands for a true 
credit — a certificate of delivery.” 4 But he fails to indi¬ 
cate how the new money could possibly be convertible 
into the endless variety of delivered commodities. “My 
solution,” says the versatile Charlie Chaplin, “would be 
to eliminate the gold standard and have the Govern¬ 
ment issue currency based on production.” It is to be 
hoped that this solution will never become as popular as 
the proposer; for, if coins or notes are to be limited merely 
by what they represent, it would do just as well to have 
them represent the energy of the sun, or the estimated 
number of fish in the ocean. Unless “representation” 
means convertibility on demand into a commodity freely 
acceptable in exchange for goods of all kinds, the com¬ 
modity basis does not necessarily guarantee the value of 
the money. Indeed, history is replete with the failures 



MONEY AND THE COMMODITY BASIS 103 

of frail human governments to limit the volumes and thus 
maintain the values of their inconvertible paper money. 

If, then, a warehouse full of tobacco is the bed-rock 
basis that guarantees the soundness of the notes that are 
issued against it, these notes must be redeemable in to¬ 
bacco. They are, in fact, Federal Tobacco notes. The 
plan must provide, in like manner, for Federal Flax 
notes, Federal Salt Fish notes, and so forth. Further- * 
more, there would have to be as many different kinds of 
Salt Fish notes as there were kinds of salt fish. Every one 
would need to have at hand the latest quotations on all 
products the market value of which fell below or danger¬ 
ously near the established fifty per cent loan value, in 
order to estimate the relative values of different kinds of 
dollars. Everybody would have to observe carefully 
whether he had Grade A Kippered Herring notes or 
Grade X Salt Cod notes. If there was a strike of bitu¬ 
minous coal miners, presumably he would hoard Bitu¬ 
minous Coal notes. If there was a slump in cotton, he 
would try to get rid of Cotton notes. To be sure, he 
would not have to reckon with Youngstown Coke dollars 
and Rumford Falls Paper Pulp dollars, as soldiers in 
France had to reckon with Bordeaux francs and St. 
Nazaire francs; for, under the Edison plan, all dollars 
would be issued by the Federal Government. But the 
currency would be just as unreliable and just as confus¬ 
ing; that is to say, if the value of each dollar depended 
on the value of the specific commodity against which it 
was issued. The unreliability would be due partly to the 
fact that farmers would naturally be most eager to bor¬ 
row from the Government on products the market value 
of which was most precarious, and on which private 
banks would not lend any money at all. 

Suppose we assume, however, that the various, stored 


io4 


MONEY 


products are not to be segregated as security for separate 
issues of notes, but that the total wealth in the ware¬ 
houses is to stand behind the total volume of notes. We 
have not thereby solved the problem of redemption. If 
there were one million dollars in commodity notes out¬ 
standing, what would it mean to say that a one dollar 
note was redeemable in a millionth part of the stored 
products? Of what would the holder’s share be com¬ 
posed, how could he collect it, and what could he do with 
it? In any event, what right would he have to demand 
any part of these products, since they are all mortgaged, 
and the Government is under obligation to keep them for 
ultimate delivery to the individual owners? 

Consider, on the other hand, the simplicity and defi¬ 
niteness of a gold-secured dollar. All the world knows 
precisely what is meant by the convertibility of a paper 
certificate into 25.8 grains of gold—.9 fine. All the world 
accepts the gold in exchange. Its value is known in every 
market. It is readily tested, stored, preserved, divided, 
transported. Moreover, gold reserves are maintained for 
the very purpose of conversion and for no other, and 
are available on demand. 

Is Edison Money really Commodity Money? 

From one of Mr. Edison’s authorized statements, how¬ 
ever, it seems that his plan does not provide for Fed¬ 
eral Tobacco notes, Federal Fish notes, and the like. In 
fact, it does not provide for any new kind of money what¬ 
ever. No matter what commodity the farmer deposits 
with Federal agents, he takes his mortgage certificate to 
a national bank and there exchanges it for Federal Re¬ 
serve notes. They are just like any other Federal Re¬ 
serve notes; just like the notes, for example, that are now 
issued by the Government, when the First National 



MONEY AND THE COMMODITY BASIS 105 

Bank of Boston rediscounts paper representing a ship¬ 
ment of shoes and asks the Reserve agent for currency. 
When the farmer examines his Edison paper dollars, he 
finds upon them nothing to indicate what commodities 
have been entrusted to the Government. 

But, if there is nothing more than this to make com¬ 
modity money sounder than gold money, this part of the 
plan vanishes into thin air. The Edison money is not 
sounder than gold money, for it is gold money. Every 
Federal Reserve note issued under the Edison plan, like 
every other United States dollar of every kind, is worth 
precisely 25.8 grains of gold; not because a farmer has 
delivered barley or beans or anything else, but because 
the Federal Reserve system has enough gold to guarantee 
the convertibility of all United States money up to the 
limits of the demand for conversion. It would make no 
difference in the purchasing power of the money borrowed 
by the farmer whether he deposited wheat or wooden 
nutmegs, bags of barley or empty sacks. Anything at all 
will do as long as the convertibility of the notes is assured 
by an adequate supply of gold. “Gold money is not good 
enough,” Mr. Edison declares. “It’s a fiction.” 1 Where¬ 
upon he proposes to issue Farmer’s Federal Reserve notes, 
their convertibility dependent on the existing gold re¬ 
serves, and insists that they will be stronger than gold 
money. 

“Why should bankers object to commodity money? ” 
we are asked. “ Is not the Government already creating 
commodity money every time it issues Federal Reserve 
notes against commercial paper? When a dealer obtains 
money from a bank in connection with a consignment of 
leather or sewing machines, does he not obtain commod¬ 
ity money?” The question is a natural one. The answer 
is “no.” “Well,” says Mr. Edison, “billions of money 


io6 


MONEY 


are now issued against commercial paper, Liberty bonds 
and Stock Exchange collateral, impalpable things you 
can’t eat or wear. What’s that?” 1 The answer is that 
money is never issued against stock exchange collateral, 
and when it is issued against commercial paper or bonds 
it is not commodity money. If Mr. Edison wished to bor¬ 
row money on a stock of phonographs, and if a Member 
Bank of the Federal Reserve System presented a ware¬ 
house receipt for the phonographs to a reserve bank, and 
received Federal Reserve notes in return, it would re¬ 
ceive gold-supported money. There would be no point in 
printing “Phonograph Dollars” across the face of each 
note. Nobody who held these dollars would care what 
Mr. Edison had in his warehouse, or what happened to 
the market for phonographs, or to the assets of the bank; 
for the value of these dollars would be determined not 
by phonographs but by gold. Reserve notes may now be 
issued that (in Mr. Edison’s use of the term) are “based” 
on shipments of bananas that spoil on the way, or shoes 
that promptly go out of style, or motors that will not run: 
but these details do not disturb the holder of the notes, 
for they are payable, not in bananas, or shoes, or motors, 
but in gold. In short, they are not commodity money at 
all: they are gold money. 

By issuing even a small volume of this money, says 
Mr. Edison, “you will have made that much of the 
country’s money better: you will have taken some of the 
load off gold.” 1 On the contrary, you will have added 
precisely that much to the load. And if the gold reserves 
become insufficient to support this additional load, either 
of two courses will be open: more gold can be obtained, 
if there is any way of obtaining more gold; or, the dollar 
of the United States, having lost its anchor of gold, can 
be left to drift away with marks and rubles. If the first 


MONEY AND THE COMMODITY BASIS 107 

course is taken, the Edison notes will not be sounder than 
gold notes: they will be gold notes. If the second course 
is taken, Edison notes will not be as sound as gold notes: 
they will be depreciated paper notes. 

Would the Edison Money be Stable in Purchasing Power? 

Mr. Edison aims to produce a money that is not only 
sounder than gold money, but a money which, he says, is 
“absolutely non-fluctuating in relative value, that is to 
say, in purchasing power.” This second aim is of para¬ 
mount importance. If Mr. Edison could provide the 
world with a monetary unit that would maintain its 
exchange value, year in and year out, he would do more 
to benefit humanity than even he has done with all his 
brilliant achievements. But his commodity dollars, as 
we have just observed, are gold dollars; and gold dollars, 
as we have all observed to our sorrow, can fluctuate 
widely in purchasing power. Once the Edison notes are 
placed in circulation, there is nothing to distinguish them 
from other Federal Reserve notes. Consequently, there 
is nothing to give them greater stability of value. 

Furthermore, the volume of Reserve notes, however 
they originate, compared with the volume of bank de¬ 
posits subject to check, is a minor factor in determining 
the price-level. Since not far from nine tenths of all 
business that involves a medium of exchange is done 
by means of bank checks, any plan for stabilizing the 
dollar that ignores bank credit ignores the major part of 
the problem. Never mind, says Mr. Edison. “One thing 
at a time. Let’s make money itself absolutely sound as 
the first step. Then the credit problem can be taken up. 
That is a vast problem. I can’t do anything with it in my 
mind — not yet. I put that aside.” 1 Mr. Edison can set 
aside the credit problem mentally, if he chooses, but he 


io8 


MONEY 


cannot for a moment set aside the influence of bank credit 
on the value of his new notes. Their value, along with the 
price-level, is affected at one and the same time by every 
dollar of currency in circulation and by every dollar of 
bank credit in circulation. He could not possibly carry 
out his plan of “ experimenting on a small scale without 
disturbance to the existing system.” He could not ex¬ 
periment on a small scale by controlling the level of the 
water in a part of a reservoir, while exercising no con¬ 
trol over the main source of the water supply. No more 
readily could he maintain an even price-level by making 
currency sound, as a first step, while ignoring bank credit. 

Presumably, however, what is called an experiment is 
regarded as a step toward the ultimate abolition of the 
gold basis. It is hoped that the new money will tend to 
displace gold as a single arbitrary “standard” and even¬ 
tually cause gold to be treated like any other commodity. 
In order to deal fully with the Edison plan, therefore, we 
must consider its possibilities as a stabilizer of monetary 
values when all gold reserves are gone. 

“Since the relative value of the earth’s produce ap¬ 
pears to be constant,” says Mr. Edison, “a money unit 
representing basic commodities and nothing else would 
be equally constant, that is, non-fluctuating in relative 
value. The true relative value of what we eat and wear 
goes neither up nor down, or very little. It is the pur¬ 
chasing power of money that varies.” 1 At other points 
in his argument, however, Mr. Edison assumes that the 
value of money does not vary. “While the gold miner 
can bring in his commodity and get full value,” he says, 
“any attempt of the farmer to attain parity is met by a 
glut and a lowering of the price of his commodity.” This 
is an illusion. The farmer and the miner get “full value” 
for their products in exactly the same sense. Each ob- 


MONEY AND THE COMMODITY BASIS 109 

tains the full exchange value of his product at the mo¬ 
ment of sale. As the value of other things goes up, the 
value of gold goes down; and vice versa. The values of 
all things, including gold, are subject to the forces of sup¬ 
ply and demand. Nothing whatever is constant in pur¬ 
chasing power. The Dearborn Independent is deceived 
by the same illusion when it says: “The law of supply 
and demand does not affect gold, or gold is not subject 
to the law of supply and demand, as we will, and this 
being the case, it is obvious that gold cannot be con¬ 
sidered a commodity.” 5 If one bases his monetary theo¬ 
ries on this fundamentally false premise, he can arrive by 
means of perfectly valid reasoning at the most astound¬ 
ing conclusions. It is not surprising, therefore, that read¬ 
ers who seldom think of questioning the truth of the 
premises are much impressed by the plausible Edison- 
Ford arguments. 

Is the Exchange Value of Farm Products relatively Constant? 

Returning now to the contention that the relative 
value of what we eat and wear goes neither up nor down, 
we may consult price-statistics. As an example of what 
we eat, we may take sugar. Not long ago, the retail price 
of sugar rose from five cents a pound to about twenty- 
five cents a pound. That was an increase of about four 
hundred per cent. In the meantime, the general price- 
level, which is an index of changes in the value of money, 
did not rise more than one hundred and fifty per cent. 
As an example of what we wear, we may take leather. 
The high price of certain grades in 1919 was nearly four 
hundred per cent above the low price of the following 
year. In the meantime, the price-level, that is to say, the 
exchange value of gold, had not changed more than forty 
per cent. Evidently, sugar and leather fluctuated in 


no 


MONEY 


value much more than gold. Nor are the exchange values 
of wheat and cotton and corn constant, either for short 
or long periods of time. The price of cotton at New York, 
during the years 1870 to 1900, ranged from 5 cents a 
pound to 27 cents a pound. The price of wheat at Chicago, 
during the years 1900 to 1909, ranged from 61 cents a 
bushel to 160 cents a bushel, and the price of corn, from 
30 cents to 88 cents. From May to October of 1898, the 
price of wheat at Chicago fell from 185 cents to 62 cents. 
From July to December of 1902, the price of corn fell 
from 88 cents to 43 cents. During 1904, the low price of 
cotton in New York was 6.8 cents and the high price 
was 16.6 cents. 6 During the World War, the fluctuations 
in the prices of many commodities were even greater. 
That the prices of twenty basic commodities, from 
1916 to 1920, rose much more rapidly than the cost 
of living is shown in Figure 5. 7 The main causes of 
many of these fluctuations were non-monetary: and 
in no case was there an exactly corresponding change 
in the purchasing power of gold. Neither is it true 
that in England wheat has always varied compara¬ 
tively little in purchasing power. Between the base 
years 1867-1877 and the year 1907, according to Sauer¬ 
beck’s index 8 of general prices in England, covering forty- 
five commodities, only eight — namely, sugar, tea, cop¬ 
per, tin, jute, hides, petroleum, and indigo — varied in 
exchange value more widely than English wheat. The 
index numbers for the average price of English wheat 
varied from 137 in 1855 to 55 in 1907, while the index 
number for the prices of all the commodities in the Sauer¬ 
beck list varied from 99 to 80. The only commodity that 
had virtually the same purchasing power in 1907 as in 
the base period was nitrate of soda; but, so far as we are 
aware, nobody has urged the adoption of nitrate of soda 



MONEY AND THE COMMODITY BASIS in 


as the standard of value. The fact is that the value of 
gold sometimes moves in the same direction as the value 
of certain farm products and sometimes in the opposite 
direction. Mr. Edison has cited periods in which the pur¬ 
chasing power of gold has varied more than the purchas¬ 
ing power of certain farm products. Others could be 


PER CENT. 



1916 1917 1916 1919 1920 1921 


Figure 5. Prices of Basic Commodities and Cost of Living, 1916-1921 


















112 


MONEY 


cited. The fact remains, however, that the relative 
value of farm products — that is to say the power to 
purchase other things — is not constant. 

Is the Volume of Farm Products an Index of Volume of Trade? 

If Mr. Edison had proposed that the total volume of 
money in circulation should be increased in proportion to 
the total annual increase of trade of all kinds , he would 
have made a proposal which, theoretically at least, would 
have tended to stabilize the purchasing power of money. 
And he would then have been face to face with the prob¬ 
lem, as yet unsolved, of devising a practical method of 
controlling the volume of money on this basis. 

From 1880 to 1920, as shown in Figure 6, crop produc¬ 
tion increased at a rate slightly in excess of two per cent 
a year, which was about the same as the rate of increase 
of population. But the average annual increase in total 
production in the United States for many years seems 
to have been about four per cent. If the volume of 
money in circulation had increased at the same rate, it is 
probable that the dollar would have varied less than it 
has varied in purchasing power. But Mr. Edison offers no 
such proposal as this. On the contrary, he would “base” 
issues of money on the volume of commodities placed in 
storage rather than on the volume of production, and on 
a few commodities rather than on all commodities. Now, 
there is no guarantee that the annual production of any 
farm product or any group of farm products will vary 
directly with the annual production of all commodities. 
We know, on the contrary, that variations in the crops of 
wheat, cotton, tobacco, and so forth, depend largely on 
certain factors, notably insects and the weather, which 
have comparatively little influence on the volume of pro¬ 
duction of other goods. Therefore, the volume of farm 


MONEY AND THE COMMODITY BASIS 113 

products at best in any given year is an unreliable index of 
the total volume of production: and evidently changes 
in the total volume of production are better measures of 
needed changes in the volume of money than changes in 
a few products; since all goods require a medium of ex- 


PRODUCTION & POPULATION 



Figure 6 
























MONEY 


114 

change, finished goods as well as raw materials, manu¬ 
factured goods as well as farm products, imported goods 
as well as home-grown goods, luxuries as well as basic 
necessities. 

In any event, however, changes in the volume of trade 
are better indications of needed changes in the volume of 
money than changes in the volume of production. It may 
yet be possible to attain a nearly perfect monetary sys¬ 
tem by making changes in the volume of money depend 
solely and promptly upon changes in the volume of 
trade. Where most of the reformers err is in assuming 
that the gold basis of money interferes with such a plan. 
It does not. 9 

Does the Edison Plan tend to balance Supply and Demand? 

The Edison plan provides an even more objectionable 
basis for currency than the total volume of farm products. 
In so far as his plan was effective, the currency would ex¬ 
pand, not in proportion to the increased production of 
farm products, but in proportion to the amount that 
farmers desired to use as security for loans. If the plan 
worked, the expansion of the currency would thus be at 
the option of one group of producers. 

There are still other flaws in the scheme. Farmers, 
naturally, would most desire to store their products and 
hold them for later markets in periods of rapidly advanc¬ 
ing prices; that is to say, at times when the purchasing 
power of the dollar was shrinking. At such times, there¬ 
fore (still assuming that the plan worked), they would 
cause expansion of the currency. But it is precisely at 
such times that further expansion of the currency is most 
objectionable, because it tends still further to reduce the 
purchasing power of the dollar. On the other hand, when 
prices were falling, many farmers would naturally try to 


MONEY AND THE COMMODITY BASIS 115 

protect themselves from further loss by withdrawing 
their stores and repaying their loans, thus, according to 
the Edison plan, reducing the volume of money in cir¬ 
culation precisely when, in the interests of a stable dollar, 
the volume of money should be increased. Consequently, 
the Edison plan, though aimed to stabilize monetary 
values, would have exactly the opposite effect. 

Indeed, it would have the opposite effect no matter 
when farmers deposited or withdrew their products: for 
steady prices depend mainly on the balance between the 
volume of goods on the market and the volume of money 
offered for goods. How that balance is upset under our 
present monetary system we shall explain in later chap¬ 
ters. Here we should note in what way the Edison plan 
upsets the balance. Under that plan, let us say, a farmer 
delivers two thousand bushels of wheat to the Govern¬ 
ment and the Government delivers one thousand dollars 
in new money to the farmer. But when the farmer de¬ 
cides to sell the wheat, he repays the loan and the Gov¬ 
ernment destroys the money. Thus the volume of money 
is increased precisely when goods are stored: the volume of 
money is decreased precisely when goods are marketed. 
In other words, each transaction begins by placing in cir¬ 
culation money without goods to match the money, and 
ends by placing in circulation goods without money to 
match the goods. Dollar-demand is created as the sup¬ 
ply of goods is withdrawn: the supply of goods is created 
as dollar-demand is withdrawn. Far from steadying the 
price-level, this is precisely the way to unsteady it. 

Would the Plan enable Farmers to borrow More Money? 

Even if this commodity-basis project would not pro¬ 
vide a sounder or more nearly stable currency, would it 
not at least enable the farmer to borrow more money on 


n6 


MONEY 


his products than he can now borrow? Apparently not. 
It seems that the Government is not expected to run 
many risks, for the farmer is allowed to borrow an 
amount no greater than one half the average value of his 
product for the previous twenty-five years. But since the 
index of prices has risen from 90 in 1896 to 269 in 1918, 10 
the amount that the farmer could borrow on most products 
would be much less than half the present value of the 
products. It would be much less, therefore, than the 
farmer could borrow directly from the banks — that is 
to say, on such of his graded products as had not fallen 
far below the value of previous years. And, on all prod¬ 
ucts that could not be graded, we assume no Govern¬ 
ment loans would be made, for there would be no way of 
determining the twenty-five-year price average. 

The suggestion is offered, however, that the farmer, 
having obtained the stipulated loan from the Govern¬ 
ment on his mortgage certificate, could then offer his 
equity certificate to a bank as security for an additional 
loan. But the equity certificate is virtually a second 
mortgage, and no bank would prefer a second mortgage 
to a first mortgage. Suppose the Old National Bank of 
Spokane was willing to lend a Walla Walla farmer $800 on 
the security of a warehouse receipt for one thousand 
bushels of wheat. Suppose, however, the farmer had 
deposited the wheat in a Federal warehouse and had ob¬ 
tained $500 from the Government. Certainly, the bank 
would not lend the farmer $300 on the equity certificate. 
The protection of the bank and its freedom of action 
would be greater if the farmer relied on the bank for the 
entire loan; for in that case the bank, in an emergency, 
could realize on its security without being obliged to pay 
$500 to get the wheat out of storage. Consequently, as a 
rule, and except in times of severe money stringency, the 


MONEY AND THE COMMODITY BASIS 117 

farmer can now borrow more money from a bank on stan¬ 
dardized farm products than he could borrow under the 
Edison plan. It is long-term loans that the banks do not 
supply him: but neither does the Edison plan. All we can 
say with certainty is that the Edison plan would enable the 
farmer to obtain some money at any time, regardless of 
the present value of his commodities and regardless of the 
condition of banks or markets. 

But this feature is not fair even to farmers: it involves 
unjust discrimination. It fixes the loan-values of all 
products, absolutely, uniformly, and arbitrarily: it ig¬ 
nores the relative prospects of different commodity mar¬ 
kets. Only by the merest chance would such a method 
give a fair loan valuation for any product whatever. Fifty 
per cent of the average price for the previous twenty-five 
years would be too high a loan-value for some commodi¬ 
ties and too low for most of them. On account of an in¬ 
creased demand for a certain grade of tobacco, for ex¬ 
ample, and a sudden scarcity of that grade, there may be 
assurance of a market price ten times as high as the pre¬ 
vious average. Or, on account of the discovery of a sub¬ 
stitute for cotton, let us say, the price of cotton may fall 
far below the average of recent years. With such details, 
the Edison plan is not concerned. Its loan-values appear 
to be fixed on the assumption that the forces of supply 
and demand have influenced prices for the past twenty- 
five years, but are of no immediate use in determining 
present loan-values. 

The general practice of the banks is not only fairer to 
farmers, but it is sounder business. There is no economic 
justification for basing the loan-value of anything upon 
average prices in past years. Sound banking practice 
looks to the future. A bank — for the protection of its 
depositors, if for no other reason — must consider above 


Ii8 


MONEY 


everything the prospects of getting its money back: and 
a farmer’s prospects of repaying a loan from the sale of 
his product depend entirely on future prices, not at all on 
past prices. Last year’s runs do not count in this year’s 
game. 

* We have said nothing as yet about the claim that the 
Edison plan would tend to abolish speculation in farm 
products. And there is not much to be said. To begin 
with, the assumption is unwarranted that organized 
speculation is detrimental to the interests of farmers. 
Many students of the subject believe that organized 
speculation tends to provide continuous markets, to 
curb price fluctuations, and to distribute risks among 
those who are best prepared to meet them. Perhaps the 
farmer would be worse off if he had to stand all the risks 
of changing prices. But we may let that pass, for there is 
nothing in the Edison plan that would tend to abolish 
speculation. Even after the farmer had stored his prod¬ 
ucts and obtained a loan from the Government — a loan 
not as large as he can now obtain ordinarily from a 
bank — he would still be free to sell his products out¬ 
right to speculators. The farmer would have all the in¬ 
ducements to sell that he has to-day, and speculators 
would have all the inducements to buy. 

Does the Commodity Money Plan involve Inflation? 

We have already spoken of the injustice of any plan 
which really provides free loans to any group of workers 
at the expense of their cooperating fellow workers in 
other fields. We are assured, however, that the Edison 
plan provides money for the farmer at virtually no ex¬ 
pense to the Government or to any one else. All the Gov¬ 
ernment has to do is to print the money. What could be 
simpler? Here we come to the most dangerous fallacy in 


MONEY AND THE COMMODITY BASIS 119 

the whole project. It is dangerous because of the univer¬ 
sal desire to get something for nothing, and the human 
incapacity for learning, even from the most painful and 
prolonged experience, even from the tragic, current ex¬ 
perience of Europe, that it is impossible to devise mone¬ 
tary schemes that will produce something out of nothing. 

Here is the gist of the matter. Money will buy what¬ 
ever is produced — not a particle more by any trick of al¬ 
chemy, or legislation, or finance. The Russians, having 
multiplied their money 257,000 times, cannot buy as 
much with it as before, because they are producing 
less. When we print more money, there are no more 
goods for money to buy: not a single additional plow, or 
hat, or potato. There is the total national wealth, pre¬ 
cisely what it was before the printing-presses were set 
in motion, except that certain rolls of paper have been 
stamped and cut up into bills. Consequently, each unit 
of money buys fewer units of goods. Those who get the 
newly printed money can buy more goods than before; 
all other people can buy fewer goods than before, be¬ 
cause their money has fallen off in purchasing power. 
Since there are no more plows, and hats, and potatoes, 
and so forth, to distribute, if some people get more, 
others must get less. It follows that if the Government 
prints money to lend to farmers free of charge, thereby 
increasing the money in circulation without increasing 
the goods that money will buy, the farmers gain im¬ 
mediately at the expense of all the rest of the population 
who spend money. If the Government is to spend more 
than its present revenue, it can obtain the additional 
money by one of two methods: by inflating the currency, 
which is surreptitious taxation of everybody who spends 
money, or by directly increasing the taxes. In either 
case, it causes economic loss to the nation. 


120 


MONEY 


Inflation under the Edison plan is limited mainly be¬ 
cause, on account of its indefensible discrimination, most 
groups of producers of goods and services are not allowed 
to participate. If all groups were included, as in fairness 
and in politics they would have to be — and if the plan 
actually provided all these groups with more money than 
they could obtain from the banks — eventually the pos¬ 
sibilities of inflation would be vast. Estimated by sources 
of production, the total income of the United States is now 
in excess of fifty billions of dollars. The total money in 
circulation, including bank deposits subject to check, is 
not far from twenty-five billions. It follows that the an¬ 
nual production, if used as a “basis” for new issues on the 
Edison plan, could at once greatly increase the volume 
of money in circulation. Every addition to the mone¬ 
tary supply would tend to raise prices. The higher prices 
became, the higher would be the loan-value of a given 
volume of goods. The greater, therefore, would be the 
volume of new money that could be issued on the basis of 
a given annual production. Prices, therefore, would be¬ 
come still higher; and so on up an endless spiral. 

In order to maintain the convertibility of such a vast 
volume of paper money, even the United States would 
not have enough gold. Such a degree of inflation, there¬ 
fore, would involve the abandonment of the gold basis, 
and this would almost inevitably lead to the abandon¬ 
ment of even such restraints as the Edison plan provides. 
The more inconvertible money a country prints, the 
more it demands. Even in Russia, where financial print¬ 
ing-presses hold the world’s record for volume, where 
new issues of two hundred trillions of rubles per 
month stagger the imagination, the people complain that 
“there is not enough money to do business with.” With¬ 
out the arbitrary restraint of the gold basis, and with 


MONEY AND THE COMMODITY BASIS 121 


Soldiers’ Bonus inflationists, Muscle Shoals inflationists, 
and sundry other kinds of inflationists constantly press¬ 
ing their claims upon Congress, it is not at all certain that 
the United States, once well on the road to financial 
chaos, would in the end be outdone by Russia. 

This is all predicated on the assumption that the plan 
would “work” — that it would enable producers to 
obtain far more money than they could otherwise ob¬ 
tain. But it would not unless — as would very likely be 
the case, once the plan was put into effect — Congress 
extended the list of acceptable commodities and the fifty 
per cent valuation limit. 

Can we safely abandon the Gold Basis? 

From this account of the advantages of gold as a basis 
of money and the disadvantages of various substitutes 
for gold, it appears that no basis has ever been used that 
is as satisfactory as gold. Indeed, the merits of the gold 
basis are so obvious, and attempts to do without it have 
been so disastrous, that many have concluded that when 
all the money of a country is really and freely convertible 
into gold, nothing further can be desired. We must ad¬ 
mit, however, that the gold basis is not ideal. The an¬ 
nual production of gold bears no known relation to the 
changing monetary needs of the world: the yearly out¬ 
put has always been subject to accidental discoveries and 
to various other unpredictable influences. Consequently, 
as we have said in previous chapters, gold has failed in 
the past to insure a stable monetary unit. In the future, 
its failure may be even greater unless, in addition to the 
gold basis, we adopt more satisfactory methods than 
have yet been employed for preventing extreme fluctua¬ 
tions in price-levels. 

Nevertheless, we must not lose sight of the fact that 


122 


MONEY 


an absolutely invariable standard of value is impossible. 
If the processes of evolution continue unchecked by cur¬ 
rent controversy, there can be nothing unchangeable to 
which a monetary unit may be related. None of the 
schemes for maintaining the value of units — not even 
Dr. Fisher’s plan for stabilizing the dollar 11 — has a per¬ 
fectly stable basis. Nowadays, the favored basis is a 
collection of commodities. But even such a standard, 
although apparently the best that can be found, will 
change from time to time, as new products appear and 
new needs arise. It is said that in Connecticut in 1921 
there was only one horse to every 2395 motor cars. The 
item of hay in the family budgets of a century ago and 
the item of gasoline in the family budgets of to-day show 
that 4 ‘ commodities used by an average family ” is a shifting 
standard. For this reason, as Dr. Fisher is well aware, 
even if we could, by shifting the weight of the dollar, 
keep it in approximately fixed relation to an index num¬ 
ber of prices, the commodity basis of the index number 
would itself be unstable. But this is not a valid ob¬ 
jection either to the use of index numbers or to attempts 
to stabilize the dollar. In the midst of a world in which 
nothing is stable, we nevertheless succeed in attaining 
degrees of stability sufficient for most human enter¬ 
prises ; and we may yet succeed in attaining a sufficiently 
stable monetary standard. 

“Must we always remain on a gold basis? Is it be¬ 
yond the wit of man to devise any equivalent method? ” 12 
These questions of Mr. Edison, the experience of the 
world is insufficient to answer. Until, however, some 
basis is proposed that is less elusive than land, or cosmic 
energy, or labor-hours, or anticipated production of fer¬ 
tilizers, or the credit of the nation, or even stored farm 
products, we should focus our attention on what we have 


MONEY AND THE COMMODITY BASIS 123 

ventured to call one of the two outstanding lessons of 
monetary history: namely, the fact that the gold basis, 
in spite of the fortuitous output of mines and the equally 
fortuitous acts of legislatures, has come nearer than any 
other basis to maintaining stability of the monetary unit. 

The present system of the United States, with its gold 
basis, is far from perfect in all its details; but the incon¬ 
vertible paper systems of Russia and Austria and Ger¬ 
many are not only defective in details, but without any 
stabilizing support in their foundations. The European 
nations which have lost the support of the gold basis ap¬ 
pear to have no prospect of restoring economic relations, 
foreign and domestic, which they all desire, until they get 
back upon a gold foundation — on some parity, new or 
old — and thus get rid of their inconvertible paper cur¬ 
rency. When we think of the way in which the United 
States dollar shrank during the World War until it had 
lost more than half its purchasing power, we look with 
scorn upon the term “gold standard”; but when we 
think of the precipitous fall of the German mark from a 
value of about twenty-four cents to less than one hun¬ 
dredth of a cent, we look with some respect, at least, upon 
the gold basis with its relative stability. Confusion is 
better than chaos. 

It may be admitted that the use of any gold basis at all 
is a concession to human weakness. So is the use of jails. 
Thus far we must go with the critics. If human beings 
were quite different, and if their political representatives 
could be counted on to act with adequate knowledge and 
complete wisdom, it might be possible to develop mone¬ 
tary systems that would automatically adjust them¬ 
selves to fluctuating business needs, and release for the 
arts the world’s stores of gold. No arrangement seems 
ideal which requires the hoarding and carrying back and 


124 


MONEY 


forth across the oceans of vast stores of gold which men 
have dug from the bowels of the earth and refined only 
with the hardest kind of labor. But there is no immediate 
need of devising an ideal system, for there are no com¬ 
munities of ideal men to use it. If all men were honest, 
the world could do away with vaults and prison bars and 
thus save tons of iron and steel. War is an utter waste: 
if nations were sufficiently wise, they would get on with¬ 
out armaments. The gold basis also involves waste: if 
nations were sufficiently wise, they would do without it. 
But nations are not sufficiently wise to abolish at once 
their prisons, or armaments, or gold reserves. With hu¬ 
manity as it is, no nation has ever kept its paper money 
within bounds without arbitrary restraint. 

We may admit the possibility that, in some far distant 
day, there may be such a widespread and accurate knowl¬ 
edge of the dependence of general welfare upon stable 
money and such a sound understanding of foreign trade 
that men will need no metallic restraint upon their ex¬ 
periments with the currency. Meantime, we have the 
satisfaction of knowing that the waste involved in storing 
and transporting gold is a minor matter: the people of the 
United States pay far more each year for chewing-gum 
than for the maintenance of gold reserves. Indeed, when 
we consider the magnitude of the interests involved, the 
waste seems negligible. Under present world monetary 
conditions, a nation may lose more material wealth in a 
year by cutting loose from its anchor of gold reserves 
than is required to maintain those reserves for a genera¬ 
tion. When business men object to the maintenance of 
large gold margins of safety, as they did in England be¬ 
fore the War, what they really object to is not the waste 
of gold, but the limitation thus imposed on note issues 
and other forms of circulating credit, whereas it is the 


MONEY AND THE COMMODITY BASIS 


125 

necessity for this very limitation which is the chief 
reason for maintaining any metallic basis at all. 

Conclusion 

We must conclude that, however interesting and even 
ultimately profitable it may be to try to devise a perfect 
form of currency for a different race of human beings, the 
immediate need is for a monetary system that will come 
the nearest to perfection in actual use among human 
beings as they are. And, as we have seen, throughout the 
long history of the processes of exchange, from primitive 
forms of barter to recent war financing, the human beings 
who have come nearest to preserving the one most elu¬ 
sive quality of their currency, namely, its stability, are 
those who have not departed from the gold basis. What¬ 
ever the defects of this system, therefore, and whatever 
modifications must be made in the interests of a greater 
stability of value than any currency has yet attained, it 
seems that we human beings — with all our defects upon 
our heads — must, at least for a long, long time to come, 
make some use of a gold basis. 


CHAPTER VIII 

MONEY AND THE RATE OF INTEREST 

From the discussion in the previous chapter, it is evident 
that most of the claims for the Edison commodity money 
are not well founded. It would not provide a money that 
is sounder than gold money; it would not provide a 
money less subject to fluctuation in value; as a rule, it 
would not enable farmers to obtain larger loans than they 
can now obtain; it would not divorce agriculture from the 
banking system; and it would not eliminate speculation 
in farm products. There remains at least one claim, how¬ 
ever, that we have not yet considered: it is said that the 
new system would provide farmers with loans, free of in¬ 
terest charges. This is a valid claim. Undoubtedly, under 
that system certain farmers would get the use of some 
money for nothing. Thus, to the extent of the interest 
charges they saved, they would have an advantage, at 
least at the outset, over all other classes of producers, in¬ 
cluding those farmers whose products were not accepted 
for storage. That much is clear. 

Should Producers of Basic Necessities have Free Loans? 

It is not clear, however, why the Government should 
grant this special privilege to any one group of producers. 
It would be a Simon-pure piece of class legislation. The 
justification for it, we are told, is the fact that the 
farmer provides us with the basic necessities of life: with¬ 
out the products of the soil, we could not live. Here 
we enter upon dangerous ground. By the same logic, we 
should grant special privileges to producers of coal and 


MONEY AND THE RATE OF INTEREST 127 

oil. Is not fuel a basic necessity? By the same logic, we 
should do something for the special advantage of manu¬ 
facturers of clothing. We cannot clothe ourselves with 
bales of cotton and wool; and clothe ourselves we must, 
according to law. Even printed matter is a basic necessity, 
if farmers are to know what is going on in the world, if 
their children are to have school books, if agricultural 
colleges are to have libraries, if farm bureaus are to make 
reports. But printers and publishers have troubles of their 
own: every year many of them fail. No doubt the Govern¬ 
ment could aid them, at least for a while, by exempting 
them from postal charges. Further illustrations are need¬ 
less. Plainly, it is folly, in the midst of the exceedingly 
complex economic organization of to-day, to try to draw 
a hard-and-fast line between those activities which are 
essential and those which are not. We might as well try to 
decide whether sodium or chlorine is the more important 
element in table salt: all we can say is that without either 
there is no salt. 

How would farmers themselves get along, in their 
efforts to feed and clothe the world, without the aid 
of those who make their machinery and fertilizers, trans¬ 
port their products, and get them finally into the hands of 
consumers? There is scarcely a duller commonplace in all 
the dull ranges of economic theory than the remark that 
farmers are just as dependent on hundreds of other groups 
of workers as these groups are dependent on farmers. The 
“ basic necessity” argument gets us nowhere. Granting 
all that can be said about the importance of the farmer’s 
work, granting the utmost that the farmer himself would 
say, we still have nothing to justify us in singling him out 
for the special privilege of free loans at the expense of all 
his cooperating fellow workers in other fields. 


128 


MONEY 


How long would Free Loans prove a Benefit ? 

And now, setting aside considerations of justice, we may 
raise the question how long free loans would greatly help 
the farmers? Not very long, for the Edison plan is based 
on still another economic fallacy. It aims to benefit a 
group of producers permanently by granting them special 
privileges. But, as a rule, those who are engaged in a 
business that is open to free competition cannot profit by 
special privileges for more than a short time. If all shoe 
manufacturers, for example, were exempted from tax¬ 
ation, the industry would soon settle down to competition 
on that basis, and producers of shoes would then be no 
better off than before. If all farmers had warehouses con¬ 
structed for them at public expense, and loans provided 
free of interest charges, competition among farmers and 
the prices of their products would be adjusted after a 
while to the new conditions. Then these Federal aids 
might prove of little advantage. 

Are Interest Charges Unjust? 

So much for helping the farmer. From the Ford-Edison 
point of view, however, this commodity money plan has 
far more to commend it than the mere fact that it helps 
the farmer, for it is regarded as a step toward the abolition 
of all interest charges. And interest, it is said, “is a tax 
that few ancient tyrants would have dared impose, ... a 
contrivance whereby all production is taxed by parasites, 
and whereby money is given a supremacy over men, 
material, and management which it cannot sustain.” 1 

Nearly as old as money itself is the idea that it is unjust 
to require the payment of interest from those who borrow 
money. One instance of this alleged injustice will serve 
as well as any other to present the viewpoint of those who 


MONEY AND THE RATE OF INTEREST 129 

maintain that governments should not pay interest on 
loans. '‘Fifty years ago,” it is said, “the City of Cleve¬ 
land installed a new pump in its water-works, laid water- 
mains and made other improvements, at a total cost of 
$400,000. The city borrowed the money on bonds to pay 
for the work. To-day, the City of Cleveland has paid 
$1,060,000 in interest on the original debt. It must go on 
for ten years more paying interest. And it still has the orig¬ 
inal cost price of $400,000, every dollar of which is unpaid. 
In 1920 the City discovered that approximately sixty per 
cent of all the money raised was already obligated for the 
payment of the interest and principal on bonds, sold in 
years gone by. Sixty cents out of each dollar, therefore, 
was being used to pay for improvements, many of which, 
like the $400,000 water-pump mentioned above, had worn 
out long before they were paid for.” 2 

No doubt it is irksome for the City of Cleveland to con¬ 
tinue to pay for its water-works long after they are use¬ 
less, just as it would be irksome for a farmer to pay interest 
on money borrowed to buy a horse long after the horse had 
died. Nobody likes to pay for a dead horse, literally or 
figuratively. But in neither case could we blame those 
who provided the money. The only economic order that 
can possibly work is one in which those who spend the 
money must incur the risks. The man who bought a Ford 
motor car with borrowed money and wore out the car 
would still have to pay the interest and principal of the 
loan. It would be childish for him to seek to avoid further 
payments merely because the car was worn out. 

What determines the Rate of Interest ? 

The desire to abolish interest is due in part to the wide¬ 
spread belief that banks themselves arbitrarily fix the rate 
of interest, with no other object in view than to make as 



MONEY 


130 

much money as possible. This belief seems absurd on the 
face of it, for it fails to explain why the banks do not make 
the rates still higher in order to make still larger profits. 
But, as we said in the previous chapter, no theories are 
too absurd to sound plausible, if we start with the false 
premise that the forces of supply and demand have noth¬ 
ing to do with the price of gold. Interest is the price we pay 
for the use of gold or — since gold is freely convertible 
into money — the price we pay for the use of money. If 
we refuse to believe that this price is determined in the 
long run by supply and demand, the way is open for us to 
jump to the conclusion that interest rates are fixed by 
“Wall Street,” or the “Gold Barons,” or the Republican 
Party, or the Federal Reserve Board, or any one else 
against whom we happen to have a prejudice. 

Mr. Ford has no difficulty in seeing that competition 
among those who wish to buy his cars is the main 
factor in determining the price of his cars; but he cannot 
see that in precisely the same way competition among 
those who want to borrow money affects the price of 
money. As a matter of fact, the price is determined by 
the forces of supply and demand, as defined at the outset 
of our discussions. 3 Neither a government nor an individ¬ 
ual can escape these economic forces, except that a govern¬ 
ment, through appeals to patriotism, may sell bonds at 
artificially low rates of interest and appear to save money 
thereby. Even in this case, interference with economic 
forces, in so far as it leads to inflation, entails eventual 
loss. Individuals and governments look to the same 
sources when they want to borrow money, and in the 
end they have to pay whatever interest is necessary 
to obtain the money. The price depends mainly on the 
relation between the total amount offered and the total 
demand of responsible borrowers. 


MONEY AND THE RATE OF INTEREST 131 

When, as in 1919, prices and wages are rising, and there 
is a general eagerness to buy goods, to hold them for 
higher prices, to enlarge business operations, and to start 
new enterprises, there are unusually heavy demands for 
money at any given rate of interest. Consequently, rates 
go up. But when, as in 1921, prices and wages are falling, 
and people are loath to buy goods, and production is cur¬ 
tailed and new enterprises are discouraged, old loans are 
paid up and the demand for new loans at a given rate 
falls off. Consequently, rates go down. Thus the price 
of money is constantly tending toward the highest point 
at which it will be possible to find trustworthy borrowers 
for the available supply. 

Does More Money mean Lower Rates? 

“The available supply!” That is exactly the trouble, 
according to the inflationist arguments. Says Mr. Ford: 
“The supply is inadequate. There is more wealth than 
there is money to move it.” Senator Capper insists that 
“cheaper money means cheaper and more abundant 
food.” 4 J. V. Nash draws a vivid picture of “the golden 
dam to the stream of prosperity.” 5 From a hundred 
quarters comes the demand for the Government to speed 
up the printing-presses, in order to crush “the money 
monopoly,” reduce interest rates, and make it easier for 
everybody to get money. 

Inflating the currency, however, though it enables 
people to get more units of currency, does not enable 
them to obtain more purchasing power, and it does 
not reduce interest rates. In all her previous history, 
Germany never had as much money or as high interest 
rates as in 1922. In the United States, during the 
industrial activity immediately following the World War, 
interest rates went up while the volume of money in- 


132 


MONEY 


creased. Then, after the break in prices, as the volume 
of money contracted, interest rates went down. Again, 
we must recall the distinction between money and other 
forms of wealth: 6 money, unlike other forms of wealth, 
is not easier to obtain simply because the total supply is 
increased. On the contrary, increasing the supply of 
money ordinarily increases the demand for money: and 
interest rates depend not on the total supply, but on the 
relation between supply and demand. 

Along with the mistaken notion that more money 
means lower rates of interest, we usually find the equally 
erroneous belief that high interest rates hamper produc¬ 
tion. The fact is that a rate of interest which truly reflects 
the scarcity of capital is most likely to keep production 
at its maximum, year in and year out. To interfere with 
the ordinary forces of supply and demand for the purpose 
of reducing interest rates is to interfere with sustained 
production. 7 

It is said that the total wealth of the United States at 
the close of 1919 was $187,739,000,000; and that the total 
money in circulation was only $7,629,429,000. “It is 
therefore evident,” we are told, “that only one thirtieth 
of the wealth of the country could be liquidated in money 
at any given time. Is it any wonder that we suffer 
periodically from the nightmare of panics?” 8 The argu¬ 
ment seems to be that if we had thirty times as much 
money in circulation, so that the total national wealth — 
all the houses, railroads, pictures, and everything else —• 
could be sold at the same moment, all our financial trou¬ 
bles would be over. That is not far from sheer non¬ 
sense. In the first place, there is no occasion for selling 
the total wealth at any given time. There are always some 
people who are willing to keep their houses, furniture, 
books, factories, cars, and clothes, at least for a few days 


MONEY AND THE RATE OF INTEREST 


133 


longer. It may be that only one thirtieth of the population 
at any given time could ride on the railroads or talk on the 
telephones; but there is no nightmare of panics on that 
account. Fortunately, never at one time do all the people 
insist on riding or talking. This indictment of our limited 
money supply is groundless, in the second place, because, 
if we increased the money in circulation thirty-fold, we 
should not necessarily be any better prepared than before 
to effect the exchange of our wealth. For, unless other 
changes had offset the influence of the inflation, the 
wealth of the country would have increased at least thirty¬ 
fold in dollar-values, and we should be in as great need 
as ever of thirty times as much money. Consequently, 
business would be no more bountifully supplied with 
money than before, and interest rates would be no lower. 

Should the Government pay Interest? 

Nevertheless, whatever the rates of interest may be, it 
is clear that the Government, by printing money instead 
of borrowing money, would be relieved of the burden of 
all interest payments. “Mr. Ford thinks it is stupid, and 
so do I,” says Mr. Edison, speaking of the Muscle Shoals 
project, “that for the loan of $30,000,000 of their own 
money, the people of the United States should be com¬ 
pelled to pay $66,000,000 — that is what it amounts to, 
with interest. People who will not turn a shovelful of 
dirt nor contribute a pound of material will collect more 
money from the United States than will the people who 
supply the material and do the work. That is the terrible 
thing about interest.” 9 

But is there really anything more terrible about pay¬ 
ing for the use of money than about paying for the use of 
anything else? Let us see. Suppose a farmer finds him¬ 
self in need of a harvesting machine, and without enough 



134 


MONEY 


money to buy one. In that case, he can either borrow a 
machine of Neighbor Brown, or borrow money and buy 
a machine. The machine is his neighbor’s capital goods: 
the money is a claim upon capital goods. The farmer 
should not expect to borrow a machine from his neighbor 
without in some way paying for the use of the machine. 
Why should he expect to borrow money — which is 
honored in the markets as an effective claim upon the 
same machine — without paying for the use of the money? 

Now, let us suppose that the farmer uses the machine 
so successfully that, after selling his crops and paying all 
his bills, he has a thousand dollars left over. With that 
money he can buy a farm and he can let Neighbor Brown 
have the use of it. Neighbor Brown, naturally, would 
expect to pay rent. Instead of buying the farm, however, 
he could lend the thousand dollars to his neighbor in 
order that his neighbor might buy the farm. In that case, 
Neighbor Brown should expect to pay rent for the money. 
All this seems clear. When the transactions are as simple 
as these, it is plain that there is just as great propriety in 
charging for the use of money as in charging for the use 
of the things that money will buy. It is equally evident 
that if men could not receive interest on their money, they 
would not lend it at all; they would convert it into prop¬ 
erty which would yield an income. Then, with the Edi¬ 
son plan in operation, nobody but farmers could obtain 
loans. 

We may assume, however, that the farmer does not 
want to buy land and Neighbor Brown does not want to 
borrow money. In that case, the farmer deposits his 
thousand dollars in a savings bank and the bank pays 
him interest for the use of his money. But the bank can 
pay interest to him only if it makes profitable use of his 
money. Now the bank finds that the City of Toledo needs 


MONEY AND THE RATE OF INTEREST 135 

a high-school building, and has decided to borrow enough 
money to construct it. In order to obtain the money, the 
city has issued bonds, each of which is a promise to pay 
one thousand dollars at a specified date and interest in 
the meantime at a specified rate. The bank buys one of 
these bonds. Thus the farmer has had a part in providing 
Toledo with a school building; and he has just as much 
right to expect interest for the use of his money as though 
he had loaned the money directly or indirectly to Neigh¬ 
bor Brown. The same principle applies to the financing 
of the Federal Government by means of the sale of bonds. 

To some people, however, it seems stupid for the 
Government to pay interest on loans. A popular alterna¬ 
tive plan is outlined as follows: “If the Government 
issued money on its own account under a well-thought- 
out, practical, automatic law, the Government would not 
have to borrow money or sell certificates of indebtedness 
(to buy them back at a premium, for that is what interest 
amounts to) or go to great expense to accommodate its 
finances through the agency of the very banks it has 
licensed to operate. ... It is a fact, that if the Govern¬ 
ment issued all money, contracting or expanding the 
currency in accordance with the nation’s economic needs, 
it would eliminate that choice bit of investment paper 
— the Government bond. . . . No Government bonds — no 
public debt — and there would be no interest.” 10 This 
is essentially the method of Soviet Russia. When public 
expenses exceed public revenues, there are two ways of 
paying the bills: by borrowing money and by printing 
money. When a government borrows money, whether it 
borrows the savings which the people have entrusted to 
the banks or borrows directly from the people through 
the sale of bonds, it must pay, as any other borrower must 
pay, whatever interest is necessary to obtain the money. 


MONEY 


136 

And, in so far as it borrows savings, it does not inflate 
the currency. But when a government pays its deficits 
by printing money, it confiscates savings instead of bor¬ 
rowing them; and it thereby pursues the very policy of 
inflation that has brought Russia to financial and in¬ 
dustrial chaos. As the Commission on Public Finance 
of the Brussels Conference said — but said in vain — to 
the League of Nations, “ The country which accepts the 
policy of budget deficits is treading the slippery path 
which leads to general ruin.” For a nation to spend 
money which is not the savings of its people is as un¬ 
sound financially as for an individual to sign checks with¬ 
out having first deposited money in the bank. 

Is a Money Economy Possible without Interest Charges ? 

All we have said so far is merely an introduction to the 
subject of interest. Assuming that we are right in our 
contention that production of goods and human welfare 
generally are best advanced in an economic order based 
on private property, individual initiative, and a medium 
of exchange, society must not only provide sufficient in¬ 
ducements for the saving of money, but also some means 
of distributing savings among the innumerable producers 
who would like to make use of these savings. That the 
institution of interest is an indispensable means will ap¬ 
pear in our discussion of Money in Production. 


CHAPTER IX 

MONEY AND INTERNATIONAL TRADE 

Although a full discussion of the problems of foreign 
exchange is beyond the scope of this volume, we should 
at least touch upon some of those monetary phases of 
international trade that are of most immediate practical 
importance and most frequently misunderstood. First 
among them is the use of gold. 

When there is a balance due from one country to 
another that cannot readily be settled by the shipment 
of any other commodity or in any other way, the balance 
is paid by the shipment of gold. Whether the gold is in 
the form of coins or bullion matters little, for in foreign 
trade it is only weight and fineness of gold that counts. 
Germany exchanges her gold for goods without any ref¬ 
erence to the value of the paper mark. A pound of gold 
that comes from China, which is not on a gold basis, or 
from Austria, which has nothing but inconvertible paper 
money, is worth precisely as much in New York as a 
pound of gold that comes from South Africa. The ex¬ 
change of goods for gold is as purely a barter transac¬ 
tion as though the balance were paid in so many pounds 
of copper or cotton, except for the supremely important 
fact that gold is universally accepted in exchange for all 
other commodities. The difference between gold and other 
bartered goods is one of degree: gold is, of all commodities, 
the most readily accepted. 

Gold as an Equalizer of Money Values 

Although commerce among the nations is thus carried 
on without an international currency, it cannot be carried 


MONEY 


138 

on extensively without an internationally recognized 
measure of value. An entirely satisfactory measure has 
not yet been used: even gold, as we have shown in the 
fourth chapter, is not a true standard. The adoption 
of international coins and bank notes on a gold basis, 
therefore, would not solve the problem. As long as the 
currency units in various countries are weights of gold of 
given fineness, those countries use in foreign trade exactly 
the same measure of value that they would use if there 
were an international gold currency. 

Thus, the gold basis of money promotes international 
trade by establishing fixed value-relationships among all 
the convertible currency units of the world. However 
the value of gold may fluctuate, the currencies of gold- 
basis countries at least have a nearly fixed relationship to 
each other. Before the War, for example, the ruble was 
redeemable for 11.94 grains of gold and the dollar for 
25.8 grains. Consequently, an Atlanta merchant could 
sell his cotton for future delivery in Petrograd at a fixed 
price in rubles and know almost exactly how many dol¬ 
lars the rubles would bring several months later. Simi¬ 
larly, the pound was never far from 4.866 times as valu¬ 
able as the dollar, because the pound contained 4.866 
times as much gold as the dollar. This relationship was 
maintained as long as both the pound and the dollar were 
freely convertible into gold, and were therefore freely 
interchangeable at the established ratio. For the same 
reason, it was easy to tell almost exactly how many dollars 
a thousand marks, or kronen, or guilders, or yen were 
worth. Thus the price quotations of all gold-basis coun¬ 
tries were linked together. Before the War, therefore, 
fluctuations in exchange rates did not paralyze interna¬ 
tional trade. 

When the currencies of any two countries are related 


MONEY AND INTERNATIONAL TRADE 139 

in this way, business between them is subject to no risk 
of exchange fluctuations beyond the cost of occasional 
shipments of gold. Whether it pays to ship gold is de¬ 
termined by market conditions. If the level of prices is 
higher in one country than in another, gold is necessarily 
cheaper in the country of higher prices, and it is therefore 
shipped in preference to other commodities. In the 
United States, for example, when the volume of money 
increases faster than the volume of trade, the purchasing 
power of the dollar declines. If it sinks below parity with 
the yen by a sufficient amount to cover cost of shipment 
and a profit on the transaction, gold is shipped to Japan, 
or to London for credit to a Japanese account. This is 
not because there is anything really “adverse” about the 
balance of trade, but simply because gold buys more in 
Japan. Gold seeks the market where its value is highest, 
measured, as all value must be, by purchasing power. 
In the main, it is subject to the economic laws that govern 
all other commodities. Before the War, therefore, if 
prices in Germany rose above those in England, it be¬ 
came more profitable to ship goods to Germany. Then 
prices in Germany tended to fall, prices in England 
tended to rise, and the flow of gold to England stopped 
or began to move in the other direction. Thus variations 
from the established exchange rate were never much more 
than the cost of shipping gold. For the same reason the 
exchange rate of the dollar and the pound usually varied 
only between 4.885 and 4.845 — the gold export and im¬ 
port points. Thus the movement of gold from one country 
to another tends to equalize the value of gold in the two r 
within the limits of the cost of shipment, by increasing 
the volume in the importing country and reducing it in 
the other. 


140 


MONEY 


Exchange Rates are not fixed by Fiat of Bankers or Govern¬ 
ments 

For this reason, it is impossible for any group of bank¬ 
ers to manipulate exchange rates, except within very 
narrow limits. Neither is it possible for any nation to 
fix exchange rates by Government fiat, unless it is pre¬ 
pared to raise huge sums by taxation and spend them for 
this purpose. Reformers fail to take into account these 
elementary principles when they insist that the United 
States Government, at no expense to itself, but merely by 
resolution, should fix official exchange rates for all cur¬ 
rencies, simultaneously post these rates at every capital, 
and thus do away automatically with foreign exchange 
speculators. 1 Almost as feasible would be a project for 
automatically abolishing variations in human nature. 

For the same reason it is folly to try to find in the rising 
exchange value of the currency in any one country an 
explanation for the increased cost of living in any other 
country. As long as the exchange rate between France 
and the United States rightly reflects the purchasing 
power of their currencies, a rise in the price of United 
States currency cannot cause a rise in the price-level of 
France. 2 

Nothing in the whole realm of finance seems clearer 
than that Germany has debased her own currency: she 
alone is responsible for the depreciation of the paper mark. 
Yet Mr. Ford’s agents blame “Wall Street.” They de¬ 
clare that international bankers in this country are re¬ 
sponsible; that they “succeeded in scaling down marks” 
by means of “legalized stealing of the worst kind”; that 
they are “literally gold-bricking the rest of the world.” 3 
All this condemnation in spite of the fact that “inter¬ 
national bankers” are powerless to prevent the fall of the 


MONEY AND INTERNATIONAL TRADE 141 

mark: they cannot possibly keep pace with the printing- 
presses, since there is not enough gold in the world to 
maintain, at pre-war gold exchange value, the present 
volumes of paper money. Such indiscriminate denuncia¬ 
tion by those who are ignorant of the first principles of 
finance is one of the real obstacles to economic progress. 

Fluctuation in Foreign Exchange 

After the War, when most currencies were no longer 
convertible, an Atlanta merchant who wished to trade 
with Petrograd, or Vienna, or Hamburg, or Paris, often 
had to meet, in addition to all the other risks of inter¬ 
national trade, the risk of losing all his profits or more 
because of the falling values of inconvertible currencies. 
It was not possible to reach a safe basis for foreign trade 
by converting paper prices into gold prices. As soon as 
the greater part of Europe abandoned the gold basis, the 
confusion was such that all price and wage comparisons 
became misleading. In February, 1921, for example, the 
wages of carpenters, in gold exchange value, were about as 
follows: in the United States, $9 per day; in Great Britain, 
$3.26; in Belgium, $1.91; in China, $0.30; in Germany, 
$0.24. That is to say, the daily wage of a carpenter in 
Germany was worth about twenty-four cents in gold. 
Many startling conclusions concerning foreign trade were 
drawn from the wide discrepancy between a daily wage 
of nine dollars in gold in the United States and twenty- 
four cents in Germany; but the German carpenter was 
spending his twenty-four cents in a country where local 
prices were no longer gold prices. Consequently, it was 
misleading to use the old methods of comparing the wages 
and prices of Germany with those of any gold-basis coun¬ 
try. 

It is not the lack of an international currency to-day 


142 


MONEY 


that hinders world trade, but the lack of a common meas¬ 
ure of value — the lack of any currency units at all within 
many commercially important countries that are main¬ 
tained in approximately fixed relation to the value of the 
gold dollar. The gold dollar, or any other piece of gold of 
known weight and fineness, serves foreign trade — with 
the aid of a little arithmetic — just as well as it serves 
domestic trade. It is not the fact that paper money 
is inconvertible that discourages foreign trade. Paper 
money, good or bad, is seldom used in foreign trade. It 
is the fact that, because it is inconvertible, it fluctuates 
in value so rapidly and so widely that a merchant who 
sells goods at paper-money prices has no means of 
knowing, even approximately, what his pay will be worth 
on the day he receives it. If the purchasing power of 
inconvertible paper money could have been guaranteed 
during the World War, it would have been more eagerly 
sought than gold, because gold itself was unstable in 
value. Following the World War, the fluctuating values 
of inconvertible currencies directly caused the breakdown 
of international trade relations; and the restoration of the 
gold basis in the chief commercial nations became the 
dominant, immediate economic problem of the world. 

When a nation is on an inconvertible paper basis, there 
is no automatic curb upon the fluctuations of foreign 
exchange, for there is no automatic curb on the issue of 
money. On the contrary, an abridgment of the freedom 
of the market for gold at once increases the difficulty: 
the greater the doubt concerning the freedom of the mar¬ 
ket, the greater is the amount of gold required to main¬ 
tain convertibility and take care of a given volume of 
internal trade. 

Furthermore, the smaller the volume of other commod¬ 
ities available for export, the greater is the need of gold 


MONEY AND INTERNATIONAL TRADE 143 

for export. But soon there is no gold to export. For, 
when economic conditions are unsound, as they were in 
most of those countries which continued, long after the 
War, to consume more goods than they produced, the 
inward flow of gold is obstructed. Excess of consumption 
over production can continue only as long as a country 
exports gold, or pays the balance with services, or with 
the income or principal of foreign investments, or suc¬ 
ceeds in getting the people of other countries to specu¬ 
late in foreign exchange. For a time, following the War, 
Germany was successful in selling marks abroad. But 
this is only a temporary expedient. On account of the 
increasingly adverse exchange rates which result, the 
people of other countries presently stop speculating and 
the excess consumption has to stop. 

Such emergencies cannot be met successfully by sus¬ 
pension or evasion of the principle of convertibility. 
For the value of money, once it has depreciated, tends to 
fall still further, because — as we have seen in previous 
chapters — more paper money is issued under the stimu¬ 
lus of rising prices, the consequent need of the Govern¬ 
ment for larger funds, and the general complaint that 
there is “not enough money to do business with.” When 
the income of an individual or a nation is less than the 
outlay, increased expenses can be met only by increased 
promises to pay. The easiest way, and at times appar¬ 
ently the only way, for a nation to make good these 
promises is by printing more paper money, or by obtain¬ 
ing bank credits in exchange for promises to pay in the 
form of certificates of indebtedness. The result is further 
fluctuations in foreign exchange; for gold does not flow 
out and thus tend to restore the balance of prices. 


144 


MONEY 


Foreign Trade requires only the Stabilization of Money Values 
in Home Markets 

It follows that the paramount economic problem of 
European countries is the stabilization on a gold basis of 
the purchasing power of monetary units in home mar¬ 
kets. 4 This is a first step toward balanced foreign trade. 
It is of far greater immediate importance than a return to 
pre-war values. For purposes of international trade, 
there is no need of bringing back the depreciated mone¬ 
tary units of Europe to their former gold parities. This 
fact is not generally understood. From the widespread 
ridicule of the franc and the mark and the krone and the 
ruble, many people have gained the impression that 
these units can never again satisfy the purposes of ex¬ 
change. On the contrary, if the purchasing power over 
commodities in the home markets of any one of these de¬ 
preciated units could be maintained at its present level, 
it would serve the purposes of foreign trade exactly as 
well as it would on any other level. 

In most European countries, new rates of exchange 
will have to be far different from the old. This, however, 
need not hamper foreign trade. The one thing needful, as 
far as rates of exchange are concerned, is that they shall 
stay where they are long enough to warrant public con¬ 
fidence in their stability. To attain that sine qua non 
of foreign trade, no international agreement is necessary. 
A fairly constant and entirely satisfactory rate between 
any two countries becomes established as soon as each 
country stabilizes the purchasing power of its own money, 
whatever that may be, in its own markets. 

It is not even necessary for either country to have any 
gold to ship to the other. So long as there is an exact bal¬ 
ance between exports and imports, there is no monetary 


MONEY AND INTERNATIONAL TRADE 145 

limit to the volume of foreign trade. It is only when the 
imports of one of the two countries exceed its exports, and 
the balance cannot be settled in any other way, that a 
shipment of gold becomes necessary. Even before the 
War, when nearly all the chief trading nations were on a 
gold basis, only a small fraction of the foreign trade of the 
world required payments in gold. 

Figure 7 is a map of Europe showing the various de- 



50 TO 75 
1 I 73 ANO OVER 

Figure 7. Depreciation of European Currencies, September, 1922 

grees of depreciation of European currencies in Septem¬ 
ber, 1922. 5 Only a motion picture, however, could show 
the main trouble; for it is not the fact that there are, at 
any one time, as many degrees of depreciation as there 




146 


MONEY 


are European currencies that hinders business, but the 
fact that nobody knows what the degrees of depreciation 
will be at any subsequent time. 

When prices reached their height in the United States 
following the War, it was frequently said that the high 
level of prices at home tended to curb trade with other 
countries. This is a mistake. For purposes of interna¬ 
tional trade, there is no such thing as a normal price- 
level. Whatever the purchasing-power parity of the 
currencies of any two countries may be, it is entirely 
satisfactory for purposes of foreign trade as soon as the 
exchanges have become adjusted to that parity. It is not 
high or low price-levels, but rapidly fluctuating price- 
levels, that hinder foreign trade. 

Fortunately so, for there is not enough productive 
power in the world to bring back the present volume of 
currencies of Europe to their pre-war purchasing power. 
Nor is there any hope of attaining enough. Production 
in the United States during the past generation seems to 
have increased at the rate of approximately four per cent 
per annum. The rate for the whole world certainly has 
not been in excess of four per cent. For the United States 
to overcome, by means of increased production at that 
rate, a degree of inflation represented by an index num¬ 
ber of 200, would take more than one generation. Ger¬ 
many would require several generations. Even if it were 
possible to prevent further inflation of the currency 
during such a long period, there would be a continuous 
tendency toward a fall in the price-level and consequent 
prolonged business depression. This is on the assumption 
that the volume of trade would increase at least as rapidly 
as the volume of production. But, under such conditions, 
it is not likely that production would increase at the rate 
of four per cent per annum. Consequently, it is not likely 


MONEY AND INTERNATIONAL TRADE 


147 


that Germany, even in a century, could restore the present 
volume of marks to pre-war values by means of increased 
production. 

Nor is there enough gold in existence to restore the 
present volume of marks to the pre-war parity with the 
dollar. To bring Russian rubles to that parity would 
require more than three hundred thousand times the 
world s stock of gold. It is doubtful whether the discov¬ 
ery of a cheap method of making gold out of baser metals 
or extracting it from the sea, or the discovery of far more 
productive mines than the world has yet known would 
ever yield enough gold to bring back the present Euro¬ 
pean currencies to their old parity. 

Furthermore, for most European countries, deflation 
would bring new disasters. To increase the value of the 
unit in which the debts of these countries have been 
contracted would render most of them insolvent, and 
would necessitate such sharp reduction of wages that 
the result would be social unrest and decreased produc¬ 
tion, if not revolution. At the very best, attempts to 
restore the currencies of Europe to their former parities 
would interfere with international trade because such at¬ 
tempts would interfere with the stability of the exchanges. 
The practical question for most European countries is 
not how soon it will be possible to restore the former 
values of their units, but how soon it will be possible to 
stabilize them at any value at all. The sooner the whole 
world accepts this fact and acts accordingly, the better 
it will be for the world. 

The Favorable Balance of Trade Fallacy 

This understanding of the part that gold plays in the 
commerce between nations should guard us against the 
fallacies that are frequently offered under the name of a 


148 


MONEY 


“favorable balance of trade.” That is a mouth-filling 
and prosperous-looking phrase. For centuries it has at¬ 
tracted many men of many nations. Indeed, it was the 
central interest of an early school of political economy, 
the Mercantilists, as they were called. Even in our day, 
some men are still talking about a favorable balance of 
trade as though it were a permanent source of national 
wealth. They seem to think that, since a merchant’s 
prosperity is measured by the amount of money he re¬ 
ceives in excess of the amount he spends, the prosperity 
of a nation can be measured by the same method. Conse¬ 
quently, they argue, the way for a nation to get rich is to 
sell more than it buys and take its pay for the balance in 
gold. The Bank Catechism , issued (in 1920) by the 
Guaranty Trust Company of New York, makes this error 
when it says: “The more we can sell to foreign countries 
at a profit, the greater becomes the wealth of this country, 
because we are getting 1 the other man’s money ’; whereas, 
when products are sold for consumption in this country, 
it is as if we took money out of one pocket and put it 
in another.” As a matter of fact, it does not necessarily 
follow that “getting the other man’s money” increases 
the wealth of this country. In the long run, it is only 
by getting the other man’s goods that we can profit by 
foreign trade; whereas, under what is called a favorable 
balance of trade, we send abroad more tangible goods 
than we receive from abroad. This is a case in which 
stating the situation in terms of goods rather than in 
terms of gold really does set up a defense against loose 
reasoning. 

Apart from the requirements of the arts, all the gold 
that any nation needs at home is enough to insure con¬ 
vertibility. After a nation has accumulated sufficient 
gold for these purposes, the only way it can gain the 


MONEY AND INTERNATIONAL TRADE 149 

maximum material benefit from sending goods abroad is 
by taking, ultimately, the full value of foreign goods or 
services in exchange. The gold itself is useless as food 
or clothing. Following the World War, for example, the 
United States gained nothing by importing vast stores of 
gold. Most of the gold that was imported after 1920 was 
not used as a basis for currency or credit expansion; and, 
if so used, it would merely have caused a more injurious 
inflation. It was of no immediate use in the United 
States; but it was immediately needed abroad to restore 
the gold basis of European currencies. 

As long as we keep all this clearly in mind, we are not 
likely to think that a country can permanently prosper 
by preventing other countries from sending in their goods. 
In England a favorable balance of trade has long been a 
sign of trouble, because England, on account of her in¬ 
vestments abroad and her services to the trade of the 
world, has regularly imported more goods than she has 
exported. The gist of the matter is that any nation, in so 
far as it exports goods in excess of its imports, usually 
increases its store of gold; but it cannot use the excess 
gold to increase the consumable goods at home except 
by making the balance of trade ^favorable. In short, 
a favorable balance of trade is advantageous, as a rule, 
merely because it makes possible a subsequent unfavor¬ 
able balance of trade. 

To this statement, one exception will be noted when we 
come to a discussion of Money in Production. There is an 
important difference between the use of gold in internal 
trade and the use of gold in external trade. When gold 
flows from one country to another, it becomes an addition 
to the base of the inverted pyramid of money in the im¬ 
porting country, and may thus increase the currency and 
bank deposits of that country many times the value of the 


150 


MONEY 


additional gold. Exchanges of gold within a country, 
however, do not change the monetary stocks of gold of 
that country. It follows that, when the production of a 
country is below the maximum, importation of gold may 
increase the wealth of that country, if it is so employed 
that it increases the purchasing power used in consump¬ 
tion of goods at home; for it may thus stimulate that 
country to produce more wealth for itself. 6 This particular 
benefit can result from the importation of gold only when 
the business of the country is in special need of a revival; 
and even at such times, more gold is not the chief need, 
since in periods of depression banks have large surplus 
reserves. 

When production is at a maximum, an increase of 
current purchasing power cannot bring about the pro¬ 
duction of more goods; so it lifts the price-level, which 
may prove far from beneficial. Nevertheless, it is because 
imports of gold thus tend toward inflation, and because 
business enjoys the stimulus (while it lasts) of rising 
prices and larger dollar-profits, that many business men 
cling to the “favorable balance of trade” fallacy. As a 
matter of fact, the long continued favorable balance of 
trade of the United States following the War, and the 
consequent accumulation of vast gold reserves, was a con¬ 
stant menace to business. 

In all countries an adverse balance of trade causes 
immediate concern; whereas an adverse balance of con¬ 
sumption over production, which is far more serious, at¬ 
tracts little attention. During the War, all the fighting 
nations used up more than they produced. They could 
do this only by destroying most of their surplus and 
much of their capital. After the War, many measures 
were passed in various countries which, in ultimate 
effect, made the balance of consumption over production 


MONEY AND INTERNATIONAL TRADE 151 

still more unfavorable, since they tended to increase the 
wages and decrease the products of labor. As Professor 
Nicholson pointed out, in his lectures at Edinburgh fol¬ 
lowing the War, it was precisely as though the nation, in 
the darkest hours of submarine warfare, had encouraged 
the people to eat more and to work less. 

The “Surplus Production” Fallacy 

There are various other approaches to the “ favorable 
balance of trade’’ fallacy. We may fall into the same 
hole even though we start on our economic journey with 
our attention fixed on goods rather than on money. 
The “surplus production of goods” route is a favorite 
thoroughfare to unsound conclusions. We travel that way 
whenever we proceed with the argument that a nation, 
in order to be prosperous, must have an outlet for its 
annual net surplus production. 

This “surplus production” fallacy is due partly to the 
failure to distinguish sharply between the interests of 
the individual and the interests of the group. Although 
rarely do we find in any country more of any economic 
goods than the people of that country want, every coun¬ 
try does have a surplus of some economic good, in the 
sense that the people as a whole would rather have what 
they can obtain from abroad in exchange for this surplus 
— wheat in the United States, for example — than to 
consume the surplus. Foreign trade on this basis ben¬ 
efits the group. 

There is another kind of “surplus,” the exporting of 
which benefits only the individual. A manufacturer of 
sewing machines, for example, may reap larger profits by 
sending twenty per cent of his product to Europe than 
by selling the whole output in the home market at lower 
prices. Prosperity — his prosperity — may, indeed, re- 


152 


MONEY 


quire a foreign outlet for his 11 surplus ’ ’; but by ‘ 1 surplus 
he sometimes means merely that he has more machines 
than he can sell at a certain price. He does not mean that 
he has more machines than the home people would like to 
buy at lower prices, and prices that would still yield him 
a profit. If the total product were sold at home, what the 
manufacturer would lose the people would gain. Indeed, 
in the long run, both might gain. The prosperity of the 
country as a whole does not necessitate selling this kind 
of a surplus abroad. 

In connection with the production of sewing machines 
for export, our manufacturer presumably distributes 
money at home as wages and as dividends; but the 
machines go abroad. In so far as he thus increases pur¬ 
chasing power that is used in home markets without 
adding any goods to home markets, he does his part 
toward lifting the price-level. The same effect on prices 
at home might result from destroying twenty per cent of 
his product and printing and placing in circulation as 
much money as would have gone into circulation as a 
result of selling twenty per cent of his product abroad. 
He cannot benefit the people at home by depriving them 
of twenty per cent of the goods they produce, and using 
“the other fellow’s money” merely to lift the level of 
prices at home. 

Obviously, each nation gains by exchanging certain 
commodities for commodities which other nations produce 
at a lower real cost: in the long run foreign trade can 
benefit a nation in no other way. It is true that imports 
are paid for to some extent with the services of trans¬ 
portation, with foreign securities, and with gold. There 
are limits, however, to each of these means of payment. 
The United States, for example, could not maintain a 
favorable balance of trade indefinitely without acquiring 


MONEY AND INTERNATIONAL TRADE 


153 


gold, or creditors, or foreign securities to an extent that 
would be harmful both to the United States and to her 
customers. Eventually, as we have said before, commod¬ 
ities must be paid for chiefly with commodities. This 
balanced exchange, however, is not the kind of trade that 
many people in the United States have in mind when they 
insist on the necessity of an outlet for our “surplus.” 
They maintain that this country normally has an output 
about fifteen or twenty per cent in excess of all it con¬ 
sumes of its own products and of those of other countries 
combined, and that its prosperity depends on perma¬ 
nently sending this surplus abroad at a money profit. If 
this argument is valid, it follows that the only way that 
all the nations of the earth can be prosperous at the same 
time is by disposing of the world’s surplus over an air 
line to Mars, or to some other planet that must be forced 
to bear the burden of this world’s superabundance. This 
reasoning is not unlike the contention that the United 
States can be safe only so long as it maintains the largest 
navy in the world, which amounts to declaring that only 
one nation in the world at any one time can possibly be 
safe. 

Periodically, it is true, there are unusually large, un¬ 
consumed stocks of goods in the United States that cause 
distress to business. But before we conclude that the only 
possible outlet for all such stocks is foreign markets, 
we shall do well to consider whether, under certain 
circumstances, the production of goods is not financed in 
such a way as to fail to place in the hands of consumers 
enough money to buy the goods at current prices. That 
question we shall meet again in connection with our dis¬ 
cussion of Money in Consumption. 


CHAPTER X 

MONEY AND THE PRICE-LEVEL 

As price is the central theme of economics and one of the 
most persistent interests in life, it is not surprising that 
there have been many controversies over the question 
what causes fluctuations in price. Particularly heated 
have been the arguments concerning the relation of 
changes in the quantity of money to changes in the price- 
level. At one extreme are those who, with Professor 
Laughlin, insist that “ price movements are in every case 
the cause of fluctuations in the volume of money in 
circulation.” At the other extreme are those who, with 
Professor Fisher, denounce “the fanatical refusal of some 
economists to admit that the price-level is in ultimate 
analysis effect and not cause.” This clash of opinion can 
be examined to best advantage by means of an equation 
of exchange. The discussion, however, will not be easy 
reading. There appears to be no way of making it easy 
without yielding to the temptation of making it seem a 
far simpler matter than it really is. Nevertheless, even 
those business men who are impatient with the abstrac¬ 
tions of economic theory may find a further study of this 
subject not without its practical advantages; for chang¬ 
ing price-levels are of vital concern to business. Indeed, 
seldom do business men get together without raising the 
question whether prices are likely to go up or down. 

In order to follow this discussion without becoming 
confused, it is necessary to keep in mind the distinction 
between the general price-level and the relation of in¬ 
dividual prices to each other on a given price-level. To 


MONEY AND THE PRICE-LEVEL 


155 


attempt to deal with these two subjects at the same time 
is confusing. Innumerable causes have a part in deter¬ 
mining individual prices — the price of a quart of milk, 
for example, or the price of a ton of coal — and never are 
the same causes operating to the same extent in any two 
individual prices. But in all cases and at all times, one 
of the causes which inevitably affects all individual prices 
is the price-level: no matter what other factors enter into 
the present prices of milk and coal, we may be sure that 
one of the factors is a general price-level much higher 
than it used to be. Coincident with any change in the 
price-level, there may or may not be a change in the rel¬ 
ative prices of milk and coal: but in this chapter we have 
nothing to do with the relation of individual prices to 
each other. It is only with factors that determine the 
general price-level that we are here concerned. In the 
following chapter we shall have something to say about 
the function of individual prices. 

Measurement of the Price-Level 

The price-level means the prices of things in general: 
it includes such diverse items as the price of a toy balloon 
and the price of an ocean liner. Nevertheless, the concep¬ 
tion of a general price-level can be made definite by means 
of index numbers. Professor Fisher, in The Making of 
Index Numbers , 1 provides us with methods of measur¬ 
ing such elusive things as fluctuations in real wages, in 
exchange rates, in volume of trade, in the cost of living, 
as well as in the purchasing power of the dollar. He tests 
not only all the formulae for index numbers that have 
been used, but as well all that reasonably could be used; 
and he tests them by means of actual calculations, 
extensive and painstaking, based on actual statistical 
records. Thus he proves that several of the methods of 


MONEY 


156 

constructing index numbers now in common use are 
grossly inaccurate; he makes clear why some formulae are 
precise and others far from it; he points out how to save 
time in the work of calculation; and he shows how to 
test the results. 

But, after all, is it possible to devise a means of meas¬ 
urement that is sufficiently precise to be used as a basis 
for determining matters of such concern to all human 
beings as contracts, currency measures, price adjustments, 
and wage schedules? The doubts on this question that 
have hitherto stood in the way of the universal use of 
index numbers must vanish before Professor Fisher’s 
demonstrations. He shows that an index number may be 
so precise an instrument that the error “probably seldom 
reaches one part in 800, or a hand’s breadth on the top of 
Washington Monument, or less than three ounces on a 
man’s weight, or a cent added to an $8 expense.” He 
shows, further, that all the forms of index numbers that 
satisfy his few, simple tests give results so nearly alike 
that it matters little or nothing, for most practical pur¬ 
poses, which form is employed. Any one of these forms 
is comparable, in point of accuracy, with many of the 
instruments that are universally and unquestioningly 
employed in other scientific fields. 

All sciences are characterized by a close approach to 
exact measurement. Without units of measurement, gen¬ 
erally understood and accepted, science could have made 
little progress. In order to determine the pressure of 
steam, we do not take a popular vote: we consult a gauge. 
Concerning a patient’s temperature, we do not ask for 
anybody’s opinion: we read a thermometer. In eco¬ 
nomics, however, as in education, though the need for 
quantitative measurement is as great as in mechanics or 
in medicine, we have been guided in the past largely by 


MONEY AND THE PRICE-LEVEL 


157 


opinions and guesses. In the future, we must substitute 
measurement for guesswork. Fortunately, we are now 
making rapid progress toward this end by employing 
those formulae that are demonstrably the most accurate 
for calculating the index numbers of general prices. 

The Equation of Exchange 

Keeping in mind the distinction between individual 
prices and the price-level, we may now consider what is 
meant by the equation of exchange. It is merely the bal¬ 
ance of all the money spent for goods and the dollar- 
values of the goods. Under the term “goods,” we here 
include all wealth, property, and services; all goods, both 
new and second-hand, both tangible and intangible. In 
the equation of exchange, therefore, we use the term 
“goods” to cover all things the transfer of which involves 
the actual transfer of money. 2 In other words, the 
equation of exchange is a summing up of all the actual 
transfers of goods for money in a given community that 
are completed within a given period of time. If we 
express this equation by saying that MV = ^pq } most 
readers exclaim at once that it is too complicated to be of 
any use. If, on the other hand, we express the equation 
by saying that, in any one time, the sum of money paid 
for goods is equal to the sum of money received for goods, 
most readers are just as promptly inclined to reject the 
equation as too simple to be of any use. In both cases, 
they speak too hastily; for in algebraic symbols it is the 
same equation as in words of one syllable, and in either 
form it may be used in such a way as to clarify the part 
that money plays in the world’s work. 

The complete equation of exchange is, then, simply the 
sum of all individual exchanges of goods for money, pre¬ 
sented on one side as a sum of payments made and on the 


158 


MONEY 


other side as a sum of goods transferred. The money, 
however, is used over and over again: the farmer who 
receives a dollar for a sack of corn may use the dollar to 
buy a hoe; the hardware dealer may then spend the same 
dollar for twine; and so on. Consequently, in any given 
year, the number of dollars spent is many times the num¬ 
ber in circulation. The money side of the equation is, 
therefore, the number of dollars in circulation multiplied 
by the number of times they are used. Or, since the num¬ 
ber of times a dollar is spent within a given period of 
time is called its velocity of circulation, we may say that 
the money side of the question is always the quantity of 
money times its velocity. Thus, if the money in circula¬ 
tion in a given country is one billion dollars, and each 
dollar is used to exchange goods twenty times in a given 
year, the money side of the equation is twenty billion 
dollars. 

The goods side of the equation must also be twenty 
billion dollars, since it is nothing but the dollar-values 
of the goods that are exchanged by means of money. It is 
the number of cars sold times the price per car, added 
to the number of bales of cotton sold times the price per 
bale, added to all the other quantities of goods sold times 
their respective prices. So far, we have offered nothing 
more debatable than the statement that 4 X 6 = (2 X 5) 
+ (7 x 2). 

The equation of exchange is just as simple, though 
less familiar, when we state it in algebraic terms. If, for 
a given year in a given community, we call the quantity 
of money M (here, as throughout this volume, using money 
to include both currency and bank deposits subject to 
check), and if we call the velocity of money spent for 
goods V, the money side of the equation becomes MV. 
If we now call the price of a given article p , and the num- 


MONEY AND THE PRICE-LEVEL 


159 

ber of those articles sold for money q , the goods side of 
the equation becomes p multiplied by q, plus the products 
of the q for every other article multiplied by its p . If we 
listed the prices and the quantities of all the goods sold 
for money in a given year — 52,385,020 packages of gum 
at 5 cents, 270 houses at $17,250, 3,480 cords of wood at 
$13.20, and so on — our list would outrun the pages of 
the biggest book. But we can sum up the entire list thus: 
2 pq. Here the algebraic symbol “2” indicates sum¬ 
mation. By Hpq we mean the sum of all the prices multi¬ 
plied by all the quantities of all the goods exchanged for 
money during the entire year. The equation of exchange 
then becomes MV = ' 2 pq. 

In discussing this equation of exchange, Professor Fisher 
distinguishes between bank deposits subject to check 
(. M f ) and currency (M); also between the velocity of 
deposits (F') and the velocity of currency (F). The 
equation of exchange then becomes M V+M'V' = 'Epq. 
For certain purposes, these distinctions are important, 
since, when the price-level is changing rapidly, the quan¬ 
tity of currency (M) by no means varies directly with 
the quantity of deposits subject to check (M f ); and the 
velocity of currency (F) by no means varies directly with 
the velocity of deposits (F'). 3 

So many people have tried to find in the equation 
of exchange something false or abstruse that we should 
perhaps say again that it is merely a statement of fact. 
In itself, the equation of exchange may seem of no im¬ 
portance — a mere truism. It is, however, of the utmost 
importance that we should draw no conclusions from it 
which do not follow logically; and it is equally important 
that we should take into account at all times the con¬ 
clusions which do logically follow regarding the relation 
to each other of the four terms of the equation. 


i6o 


MONEY 


The Quantity of Money in Relation to the Price-Level 

What are the conclusions that are usually drawn from 
this equation? It is said to follow in general that, if there 
is a change in any one of the four terms, there must be 
an exactly offsetting change in one or more of the other 
terms. Consequently, it is said, all other factors in the 
equation remaining the same: 

(1) The price-level varies directly as the quantity of 
money. 

(2) The price-level varies directly as the velocity of 
money. 

(3) The price-level varies inversely as the volume of 
goods transferred by money. 

The price-level, therefore, is said to vary directly with 
the quantity of money in circulation, provided the veloc¬ 
ity of circulation of that money and the volume of trade 
for which it is employed are not changed. This conclu¬ 
sion was well expressed by Simon Newcomb, as follows: 
“When the volume of the currency fluctuates, other con¬ 
ditions being equal , the purchasing power of each unit of 
money varies inversely as the whole number of units, 
so that the total absolute value of the whole volume of 
currency remains unaltered by changes in that volume.” 4 
All these conclusions are sound. They hold absolutely: 
there is no need of making the qualifications that are 
often made. They hold true both for short and for long 
periods of time, and for abnormal periods, however we 
may define “abnormal,” and for transitional periods, as 
well as for all other periods. 

Before we conclude, however, that changes in the price- 
level are always caused by changes in the quantity of 
money, we should note that logically we can draw from 


MONEY AND THE PRICE-LEVEL 


161 

the equation of exchange another set of conclusions. 
Other factors in the equation remaining the same: 

(1) The quantity of money varies directly as the price- 
level. 

(2) The quantity of money varies inversely as the velocity. 

(3) The quantity of money varies directly as the volume 
of goods transferred by money. 

Evidently, the equation of exchange tells us nothing 
whatever concerning the causal connection between 
changes in the price-level and changes in the volume of 
money. The equation remains true whether a rise in 
prices is due to an increased quantity of money, or an 
increased quantity of money is due to a rise in prices. 

The Quantity Theory of Money 

Those who believe that an increased quantity of 
money, without a change in the supply of commodities, 
must result in an exactly proportional rise in the price- 
level, are rigid “quantity theorists.” A recent exposition 
of their views by one of the most distinguished of mone¬ 
tary authorities may serve as well as any other to show 
what is usually meant by the quantity theory. In 
Money and Foreign Exchange after 1914 (p. 53) Gus¬ 
tav Cassel says: “A diminution in the supply of commod¬ 
ities should properly call for a corresponding reduction in 
the community’s supply of currency. If this is done, then 
the price-level must remain unaltered. If, on the other 
hand, it is not done, but the community’s supply of cur¬ 
rency remains unaltered, in spite of a scarcity of com¬ 
modities having arisen, it is obvious that a general rise in 
prices must follow. This rise in prices must be propor¬ 
tional to the plentifulness of the supply of currency — 
i.e., it must be determined by the relation between the 


MONEY 


162 

actual quantity of currency and that which would have 
conformed to the new reduced supply of commodities. 
Let us imagine that it would be possible to express the 
supply of commodities statistically by an index number, 
and let us further imagine that this index number has 
sunk from 100 to 80 — i.e., that the community’s supply 
of commodities has been reduced by 20 per cent — then, 
according to this reasoning, the supply of currency 
would also have gone down from 100 to 80. If it has not 
done so, but has remained at 100, then it is too plentiful 
in the proportion 100:80, and the consequence must be a 
rise in prices in the same proportion — i.e., the general 
price-level must be raised from 100 to 125. . . . If we sup¬ 
pose that the community’s supply of currency was in¬ 
creased to double the normal amount, while the supply of 
commodities went down from 100 to 80, then from the 
first cause a rise in prices from 100 to 200 must result, 
and from the second cause a rise in prices from 100 to 125. 
The total rise in prices must, then, have been from 100 to 
250.” This statement of the quantity theory, we cannot 
accept, because it holds true only if “all other factors re¬ 
main the same.” 

The Assumption that “All Other Factors remain the Same” 

In our exposition, we have placed in italics the assump¬ 
tion that all other factors remain the same; for it is to this 
assumption that we should direct our attention. Failure 
to take it duly into account has been responsible for most 
of the controversy, some of it not far from acrimonious, 
that has raged around this subject. 

The truth is that other factors never do remain exactly 
the same. Consequently, when we say that the price- 
level varies directly with the quantity of money in cir¬ 
culation, all other factors remaining the same , we confine 


MONEY AND THE PRICE-LEVEL 


163 

ourselves to hypothetical conditions. As Professor Fisher 
himself says, “The proposition that prices vary with 
money holds true only in comparing two imaginary 
periods.’’ In the actual world of business, these “other 
factors” are constantly changing. The conclusions 
which are logically drawn from the equation of exchange 
when the assumption in question is made never hold 
true of actual business conditions, for concerning such 
conditions the assumption is unwarranted. Consequently: 

(1) The price-level never varies directly as the quantity 
of money. 

(2) The price-level never varies directly as the velocity 
of money. 

(3) The price-level never varies inversely as the volume 
of goods transferred by money. 

This does not warrant us in condemning the equation 
of exchange as useless, for in economics, as in engineering, 
there is no way of discussing the operation of any force or 
law except under certain assumed conditions. 5 The trouble 
is that when we assume that other things remain equal, 
we sometimes forget, after a while, that we have made an 
assumption, and we are then in danger of drawing con¬ 
clusions as though our assumption were an established 
fact. It is partly because business men have observed 
errors of this kind that many of them have rejected the 
equation of exchange. Rather than reject it, they would 
do well to learn more about those other changing factors. 
Let us now consider the most important of them. 

Goods are transferred without Money and Money without 
Goods 

The equation of exchange does not take due account 
of all the influences that affect the actual price-level 


MONEY 


164 

during any given period of time, because it takes no ac¬ 
count of the volume of goods that are transferred without 
the transfer of money and the volume of money that is 
paid for goods when no goods change hands. Such trans¬ 
actions take place constantly and to an extent that can¬ 
not possibly be predicted in advance. Oswald St. Clair 
appears to fall into the common error of overlooking this 
factor when he says: “Where does the money income 
come from? From the sale of goods and services. The one 
stream exchanges for the other and is necessarily equal to 
the other. The magnitude of the one is measured against 
the magnitude of the other and thereby is determined 
what we call the general level of prices.” 6 This is not an 
accurate description of the trade of any given month or 
year; consequently, it cannot fully explain the general 
level of prices in any given month or year. Within any 
given period of time, a volume of goods is purchased 
without the expenditure of money: the debts are carried 
on open book accounts. Money may or may not be used 
at a later period on account of these transfers of goods; 
but, during the period in question, these transactions on 
the goods side of the equation of exchange have no 
counterpart on the money side. On the other hand, in 
any period of time, there are transfers of money in pay¬ 
ment for goods which have changed hands previous to 
the period in question. So there are always transactions 
on the money side of the equation that have no counter¬ 
part on the goods side. 

Suppose we allow M" to stand for the money that is 
paid for goods in a given year without the transfer of 
goods, and T" to stand for the goods that are transferred 
in that year without the payment of money. Now, the 
significant facts are that neither M" nor T" are exactly 
the same for any two periods of time, nor do they main- 


MONEY AND THE PRICE-LEVEL 


165 

tain fixed relations to M and T , or to each other. That is 
to say, M" and T" are among those other factors which 
never do remain the same. 

These transactions, therefore, make the price-level of 
the equation of exchange for any given period different 
from the actual price-level. Goods transferred without 
money ( T") do affect the actual price-level, but they do 
not affect the price-level in the equation of exchange. 
Leather, for example, that is sold but not paid for in any 
given period has its part in determining prices of leather, 
and prices of leather have their part in determining the 
general price-level. But leather, if sold and not paid for, 
does not appear in the equation of exchange. Since it is 
not included in T, it cannot affect P. On account of 
these factors, which never do remain equal, the price- 
level in the equation of exchange (P) is the price-level of 
an imaginary period, never the price-level with which 
business has to deal. 

When we look upon the equation of exchange as 
though it were a complete picture of trade, we naturally 
conclude that goods and money cannot affect price- 
levels within a given period of time unless they have 
actually been exchanged. This is one of the errors that is 
commonly involved in discussions of the quantity theory. 
“Neither goods nor gold,” says Oswald St. Clair, “so 
long as they remain withdrawn from the two streams 
that are constantly measuring themselves against one 
another, exercises any influence on the ratio called 
price.” 7 They do influence price, however, because the 
volume of money which is available but not used during a 
given period, and the volume of goods which are on hand 
but not sold, have their part in determining the policies 
of the banks in making loans and the extent to which 
merchants are willing to extend credit and to buy on 


l66 


MONEY 


credit. Whenever merchants sell on credit, the goods are 
sold at a price, and the price has the same immediate 
effect on the market as though the goods were sold for 
money. Thus, by affecting the volume of goods trans¬ 
ferred without money {T"), both goods and gold that 
are outside the currents of exchange may play a part in 
determining price-levels. 

» Furthermore, there are periods during which M" and 
T" fall far short of balancing. If this were not the case — 
if the volume of money transferred without goods and 
the volume of goods transferred without money actually 
did offset each other, or very nearly so, within a suffi¬ 
ciently short period of time — such transactions would 
not interfere with the practical uses of the equation of 
exchange in connection with short-time business ven¬ 
tures. Simon Newcomb assumed that they did offset 
each other. ‘‘Taking each year by itself,” he wrote, 
“the chances are that the excess of industrial circulation 
arising in this way towards the end of the year will be 
balanced by the payment of debts incurred during the 
year before.” 8 Probably there was no such balance even 
in his generation. Certainly there has been no such bal¬ 
ance during the past decade. Whenever the price-level is 
changing, the discrepancies between M" and T" do not 
offset each other within any given year; and a year is 
time enough for a violent change in the price-level and 
for a business crisis. At certain stages of the business 
cycle, transfers of goods without money far outrun 
transfers of money without goods. At other stages, the 
opposite condition prevails. 

These discrepancies could not be vast if, as some dis¬ 
cussions assume, the volume of trade varied directly with 
the volume of production. It does not. Obvious as 
the fact appears, it is not taken into account by many of 


MONEY AND THE PRICE-LEVEL 


167 

those who slip in the phrase “other factors being equal.” 
Among the other factors which do not remain equal is 
the relation between the volume of production and the 
volume of trade. 

Quantity of Money and the Price-Level under “ Normal Busi¬ 
ness Conditions ” 

In any given year, then, since “other factors” may 
be disastrously far from equal, the conclusions that are 
usually drawn concerning the relation of the quantity of 
money to the price-level do not necessarily hold true. 
Admitting this, however, there are many who contend 
that the conclusions hold true for short periods of time 
under normal business conditions , and that they always 
hold true in the long run. 

In answer to that contention, it may be said that, from 
the standpoint of the immediate interests of business, 
any theory is limited in usefulness that applies only to 
“normal” conditions. Strictly speaking, there is no such 
thing as “normal” business conditions: “other factors” 
never do remain exactly the same or in exactly the same 
relations. If, however, we vaguely call business normal 
when, as in the period from 1909 to 1913, fluctuations in 
price-levels, in employment, in volume of production, and 
in volume of trade are comparatively slight, and if it is 
only in such periods that a given theory is useful, evi¬ 
dently it is not useful in those periods in which business 
men are chiefly interested and concerning which they are 
in greatest need of enlightenment. It is when prices are 
rapidly„rising or falling, and the country seems headed 
for a boom or a depression, that there is most urgent need 
of further knowledge concerning the relation of money to 
prices. In such times, we are told, the price-level does not 
vary directly with the quantity of money. 


MONEY 


168 

Evidently it does not. When money is produced much 
more rapidly than goods, prices of goods are likely to 
increase out of proportion to increases in the volume of 
money. In Russia, for example, for a number of months 
following the World War, depreciation of money, accord¬ 
ing to J. M. Keynes, proceeded at least three times as 
rapidly as would have been possible had the quantity 
theory applied, without qualification, to this period. And 
in Germany, during 1922, according to the Manchester 
(England) Guardian , “panic demand for goods and for¬ 
eign exchange drove prices and exchange rates to a height 
out of all proportion to increase in currency, fabulous 
though that appears.” 8 This is not surprising. There is 
always a tendency to withhold goods when they are daily 
increasing in value, and to spend money when it is daily 
decreasing in value. When there is a general expectation 
that prices will soon be higher, more money is required to 
induce any one to part with his goods than when the 
price-level is relatively stable. In other words, increasing 
reluctance to part with goods for money has the effect of 
advancing prices in anticipation of new issues of money. 
For this reason, the price-level of any particular day 
within a period of inflation could not long be sustained 
without a still larger volume of money. Consequently, 
when the volume of money stops expanding, prices are 
likely to break quickly; and, once prices have stopped 
advancing, they move downward more rapidly than the 
volume of money contracts. Thus, whether prices are 
going up or going down, the changes are not in direct 
proportion to changes in the quantity of money. 

The Quantity Theory in the Long Run 

The “other factors” of which we have been speaking 
tend to remain equal only over long periods of time. 


MONEY AND THE PRICE-LEVEL 169 

This is a circumstance that puts all statements of the 
quantity theory still further beyond the range of most 
of the immediate interests of the business man. “The 
theory may hold true,” he says, “after this unsettled 
period of transition is over. LTnfortunately for me, I have 
to do business throughout the period. It is the wages, 
prices, bank rates, and markets of to-day with which I 
have to deal. Before changes in the volume of money 
have had time to produce their full effects in accordance 
with the quantity theory, I shall have borrowed money, 
bought raw materials, paid workmen, sold the products, 
repaid the bank loans, and gained a profit or sustained 
a loss. Consequently, whatever the ultimate effects of 
monetary policies may be, I am forced to deal daily with 
the immediate effects.” 

It is true that in the long run those other factors tend 
to remain in constant relation to the four factors in the 
equation of exchange. The physical volume of trade 
tends to become equal to the physical volume of produc¬ 
tion, because eventually nearly all the goods that are 
produced are sold; and the excess, in any one year, of the 
dollar-values of goods sold over the dollars paid for goods 
tends to become balanced in subsequent years by the ex¬ 
cess of dollars paid for goods over the dollar-values of 
the goods sold. 

It is true, also, that, in the long run, the physical volume 
of trade is not greatly enlarged by increases in the volume 
of money in circulation. Quite the contrary is sometimes 
true, as recent trade reports from Europe bear witness. 
But when a country is on a gold basis, and business is in 
the doldrums, and large numbers of men are unemployed, 
an increase in the volume of money in circulation that 
promptly gets into consumers’ hands as wages, or divi¬ 
dends, or bonuses, is an immediate stimulus to business. 


170 


MONEY 


As a result there may be and often is an increase in the 
volume of money and almost immediately afterward an 
increase in the physical volume of trade. 

It is true also that, in the long run, the volume of stock 
speculation, in numbers of shares, is not greatly enlarged 
by an enlarged volume of money in circulation. But at 
certain stages of the business cycle, a considerable in¬ 
crease in the volume of money in circulation, or even low 
interest rates leading to an expansion of loans, is certain 
to be accompanied by increased activity in the stock ex¬ 
changes out of proportion to increased production of 
goods. That this was the case in 1919 is evident from 
Figure 12 9 which shows that the loans of New York City 
banks increased during that year of feverish business ac¬ 
tivity much more rapidly than the loans of all reporting 
banks. Any change whatever in the volume of money is 
likely to carry with it, in any given year, not only a change 
in the total volume of trade, but also still more important 
changes in the relative volumes of different kinds of 
trade. Furthermore, any change whatever in the quan¬ 
tity of money is likely to be accompanied by some change 
in the velocity of money, and by other changes in the cir¬ 
culation which are more important than changes in the 
velocity of money in general. 10 

Long-run changes in the actual price-level must be due 
mainly to changes in the relation between the volume of 
trade and the volume of money in circulation, because 
over long periods of time all “other factors” become 
minor if not negligible. On any given day, however, 
some account must be taken not only of material facts, 
but as well of what people think about the facts. Prices 
have to do with states of mind as well as with states of 
matter. Although in the long run changing price-levels 
must indicate changing relationship between the volume 


MONEY AND THE PRICE-LEVEL 


I7i 

of goods and the volume of money, it is true that, for a 
while and to some extent, the changing price-level may 
be due indirectly to the belief that something has hap¬ 
pened or will happen to goods, or to money, or to both. 
Beliefs influence prices not only because they lead to 
changes in M and V and T, and in M" and T", but also 
because they affect these “other factors.” In the long 
run, however, the price-level moves with real rather than 
with supposed or anticipated movements of goods and of 
money. 

But, whatever may be true in the long run, the im¬ 
mediate effect of an increase or decrease of money in cir¬ 
culation is not an exactly proportional increase in the 
commodity price-level. Nor does a change in the com¬ 
modity price-level always produce an equivalent increase 
or decrease of money in circulation. The slack may be 
taken up by other factors included in the equation of 
exchange, or by factors summed up in M" or T". As the 
volume of money changes, other factors that influence 
price-levels also change. 

The Equation of Exchange is too General 

There are other particulars in which the equation of 
exchange fails us in connection with our inquiries con¬ 
cerning the immediately practical affairs of business. 

The equation of exchange in its general form fails to 
serve our purpose, first of all, because its price-level in¬ 
cludes all goods and all services. It lumps together 
all commodity transactions, wholesale and retail. The 
equation is affected in the same way by the sales of the 
American Wholesale Corporation as by an equal volume 
of the sales of the Woolworth Stores. It is impossible, 
however, to analyze the causes or to follow the course 
of business fluctuations without distinguishing carefully 


172 


MONEY 


between money spent for goods at wholesale and money 
spent for other goods. Changes in the total volume of 
trade may have less to do with initiating business de¬ 
pressions and revivals (as we may be able to show later on) 
than changes in the relative amounts of money spent in 
consumption and in production. But the general equa¬ 
tion of exchange deals only with grand totals. 

The equation of exchange in its general form fails to 
serve our purpose, in the second place, because there are 
various other price-levels that have as much to do with 
the decisions of any given business day as the price-level 
of goods and services in general. There is not only a 
wholesale price-level for new goods and a retail price- 
level for new goods, but also a price-level for second-hand 
goods. There are price-levels for railroad freight rates 
and common labor, as well as for fuel and building ma¬ 
terials. There are also price-levels for real estate, for 
money, for bonds and for stocks. It is with these par¬ 
ticular price-levels, especially in their relation to other 
price-levels, that the banker and the business man is im¬ 
mediately concerned in the transactions of a given day. 

Ordinarily, in current discussions, the term “price- 
lever’ refers to new goods at wholesale. But the whole¬ 
sale price-level could not vary directly with the quantity 
of money, velocity of money and volume of trade re¬ 
maining the same, unless the relative amounts of money 
spent for goods at wholesale and for other purposes — 
for goods at retail, for second-hand goods, for services, 
for real estate, for bonds, for stocks, and so forth — re¬ 
mained the same regardless of changes in the total volume 
of money in circulation. The fact is that they do not 
remain the same, individually or as a group: the propor¬ 
tions spent for these purposes vary greatly at different 
stages of the processes of inflation and deflation. For 


MONEY AND THE PRICE-LEVEL 


173 


certain practical purposes, therefore, we must qualify 
any statement of the quantity theory with respect to the 
particular price-level of which we are speaking. The 
price-level of goods sold at wholesale does not vary 
directly with the quantity of money in circulation, other 
factors remaining equal, but with the quantity of money 
spent for goods at wholesale, other factors remaining 
equal. Between money spent in consumption, moreover, 
and money spent for other uses, there is not a fixed ratio. 
On the contrary, various forces arise in the ordinary course 
of business which tend to alter, first in one direction and 
then in the other, the ratio between the money used to 
place goods on consumers’ markets and the money used 
to take the goods away. 

Nor does the equation of exchange separate money spent 
for capital goods from money spent for consumers’ goods. 
Such a distinction would not be of great importance, in 
connection with studies of price fluctuations, if expendi¬ 
tures for capital goods always increased in about the same 
proportion as expenditures for other goods. But, as we 
shall show in later chapters, this is far from being the case 
and the consequences deserve study. Before we can make 
much use of the equation of exchange in explaining busi¬ 
ness fluctuations, we must take account of the relative 
flow of various kinds of trade. 

At this point, lest our equations and figures of speech 
may convey the wrong impression, we should perhaps 
mention the fact that none of these changes in the flow of 
money are mechanical: they are all due to human choices: 
money flows wherever individual preferences direct the 
flow. 

The Equation deals only with Velocity in General 

Another deficiency of the equation of exchange is that 


174 


MONEY 


it deals only with the velocity of money as a whole. Here, 
again, quantities are lumped together which have differ¬ 
ent effects on business. Sustained production and sus¬ 
tained prices depend chiefly on the relationship between 
the use of money in consumption and the use of money for 
other purposes. 10 Therefore, we have less interest in the 
velocity of money in general than we have in the relative 
velocity of money used in consumption and money used 
for other purposes. If a given volume of money increases 
its rate of turnover, it makes no difference to the equation 
of exchange whether the increase takes place in whole¬ 
sale markets or in retail markets: but it does make a dif¬ 
ference to business. Indeed, it makes a crucial difference. 
If a million dollars in the hands of traders increases its 
velocity and thereby facilitates an additional transfer 
of a stock of leather on the way to shoe factories, it has 
precisely the same effect on the price-level in the general 
equation as though a million dollars in the hands of con¬ 
sumers had increased its velocity and had thereby in¬ 
creased the sales of retail shoe stores. 11 But it has a 
different effect on retail prices and consequently a differ¬ 
ent effect on business as a whole. The sales of finished 
goods to consumers do not vary directly with changes 
in the velocity of money used in wholesale markets, or in 
stock markets, or with changes in the velocity of money 
in general. In the long run, other things being equal, they 
do vary directly with the frequency with which money is 
spent in consumption. How long does it take for a dollar 
that is spent in consumption to get around to another use 
in consumption? In other words, what is the circuit time 
of money? And, during the circuit, how many times 
has the dollar been used to effect exchanges of a differ¬ 
ent character? With these questions, the equation of 
exchange has nothing to do. Yet, the answers to these 


MONEY AND THE PRICE-LEVEL 


175 


questions may go as far toward explaining business in¬ 
stability as anything we now know or are likely to dis¬ 
cover concerning the velocity of money in general. 12 

Summary of Remarks concerning the Equation of Exchange 

To sum up our observations concerning the equation 
of exchange, we should say, first of all, that it is a state¬ 
ment of fact: it is true without qualification. But con¬ 
clusions drawn from it, on the assumption that other 
things are equal, would be applicable only to an imagi¬ 
nary business world. The equation of exchange is further 
defective as a basis for conclusions concerning the real 
price-levels of any particular year, because it takes no 
account of changing factors that affect price-levels, in¬ 
cluding transfers of money without goods, and transfers 
of goods without money. The equation of exchange, 
moreover, is too general to carry us far toward an under¬ 
standing of the immediate causes of fluctuations in the 
specific price-levels with which ordinary business is daily 
concerned. It is too general because it lumps together ex¬ 
changes of different kinds of goods that must be con¬ 
sidered separately. It is too general, furthermore, be¬ 
cause, in order to make progress toward an understanding 
of the causes of business depressions, we need to consider, 
not only the velocity of money in general, but also — 
among other factors — the frequency of the use of money 
in consumption compared with the frequency of its use 
for other purposes. 

The Practical Value of the Quantity Theory 

According to a common form of the quantity theory, 
the purchasing power of money, other things remaining 
equal, varies with the number of the units. We can readily 
assume conditions under which other things really would 


176 


MONEY 


remain equal and, consequently, the value of the unit 
would vary exactly in proportion to changes in the num¬ 
ber of units; that is to say, conditions under which the 
purchasing power of the dollar would decrease in exact 
proportion to the increase in the number of dollars in 
circulation. But, as we have just observed, such condi¬ 
tions never exist in the complicated commercial world of 
to-day. Numerous factors, besides changes in the quantity 
of money, have their part in determining changes in the 
purchasing power of money. These other factors are so 
obvious, and so variable, and so difficult to measure, and 
at times really are of such importance, that the signifi¬ 
cance of the quantity factor is often obscured. Some of 
those who think of themselves as practical business men, 
as distinguished from theoretical economists, are in¬ 
clined to reject, in all forms, what is called the quantity 
theory of money. Why waste time in even discussing 
conclusions which, according to their own champions, 
apply only to an imaginary world! 

But should we impatiently reject considerations of 
quantity because factors other than quantity must be 
taken into consideration, and because the theory fails 
fully to explain the conditions that confront us at a given 
moment? Should we not rather remind ourselves that all 
relations — not only those that involve human beings, 
but those in the physical world as well — are exceedingly 
complex, and all theories would have been rejected in 
their entirety, if men had been unwilling patiently to 
study the varied operations of forces, under varied at¬ 
tendant circumstances? 

We know, for example, that in general the heart action 
varies in proportion to the amount of a given stimulant, 
and this knowledge is put to timely, practical use by 
physicians all over the world. Rarely, however, can 



MONEY AND THE PRICE-LEVEL 


177 

any one predict, in any particular case, exactly what 
changes will result from a given quantity of a given 
stimulant. There are always other factors which tend to 
offset or to augment the effects of the stimulant. We do 
not, for that reason, scout the theory; we merely do our 
best, in each case, to discover and to measure those other 
factors. 

To use an example which is even more familiar to 
business men, we may consider “the law of supply and 
demand .’* Every business man has profound respect for 
this so-called “law.” He believes that he sees it in daily 
operation. Some of the favorite theories of economists 
seem to him to correspond not at all with what he sees 
going on about him in the familiar world of commerce; 
but to him the law of supply and demand is more than a 
theory, for he meets it at every turn. By the law of 
supply and demand, he usually means that if the demand 
for a given commodity increases faster than the supply, 
the price of that commodity goes up: if the supply in¬ 
creases faster than the demand, the price goes down. To 
illustrate by means of an example, he will tell you that if 
the number of men wishing to buy Walk-Over shoes, and 
having the money to buy them at current prices, increases 
faster than the supply of Walk-Over shoes, the price will 
go up; and vice versa. 

If, however, our business man knows something about 
economic history, or is a careful observer of current 
events, he can cite instances in which increased demand 
has resulted in no change in prices, or even in lower prices. 
He knows that during the War increased demand for 
aluminum, out of proportion to increased supplies, did 
not result in proportionately higher prices. He can cite 
numerous widely advertised specialties — chewing gum, 
washing powders, to go no further — which were sold, 


MONEY 


178 

during the War and after, at the pre-war prices, regardless 
of the increase in the number of those who wanted these 
articles and in the amount of money they had to spend. 
And everybody knows that in recent years the demand 
for Ford cars has gone up and the price down. Evidently 
there are “other factors” that do not “remain the same.” 

Nevertheless, the business man’s belief in the law of 
supply and demand, and his conviction of its great im¬ 
portance in commerce, remain unshaken. For whatever 
special circumstances may, for the moment, or, in the 
case of certain commodities, tend to obscure the operation 
of the forces of supply and demand, the man of business 
still considers them the factors which above all others he 
must consider in his attempt to explain or predict price 
movements. 

If he applies the same reasoning to monetary problems, , 
he will not discard the quantity theory of money as 
useless, merely because he has observed cases in which a 
known increase in the quantity of money has not been 
followed by proportional decrease in the value of the 
dollar; or cases in which changes in the price-level, which 
he has known only too well, have occurred with virtually 
no change in the quantity of money. On the contrary, he 
will look upon the quantity of money as the largest of 
the universal factors in the long-run determination of 
prices. And he will attempt to discover and measure 
those other factors which do tend, at times, to prevent 
the price-level from varying in exact proportion to varia¬ 
tions in the quantity of money and to prevent the quan¬ 
tity of money from varying as prices rise or fall. 

The connection between the quantity of money and the 
price-level is just as definite and clear as the relation be¬ 
tween supply and demand and the price of a pair of shoes. 
If, for the moment, the connection is obscured by special 


MONEY AND THE PRICE-LEVEL 


179 


circumstances, we have only to take a broad survey of 
centuries of experience in numerous countries. We find 
that, invariably, notable discoveries of silver resulting in 
new supplies, in the days when silver money was more 
important than gold money, were followed by an increase 
in the price-level; and that, after gold became the measure 
of value of the leading financial nations, extraordinary 
increases in the supply of gold were followed presently by 
similar rises in the price-level. 

We find, on the other hand, that when production of 
goods increased at a faster rate than the supply of gold, 
and when substitutes for gold were not used to make up 
the deficiency, there was a fall in the general price-level. 
From 1876 to 1896, for example, there were substantial 
increases all over the world in the activities that required 
a medium of exchange; but there was not a corresponding 
increase in the world’s supply of gold, and prices fell in 
all the chief trading centers of the world. This movement 
was not checked in the United States, or elsewhere, un¬ 
til the quantity of money and substitutes for money in¬ 
creased out of proportion to increases in goods to be ex¬ 
changed by means of money. Here, as in the case of the 
law of supply and demand, the connection is far from 
clear; it may even seem to be wanting altogether, if we 
fix attention upon any one country at any one time. 
But if we divest ourselves of all prejudice, and minimize 
the effects of local and temporary conditions by making 
long-range studies, in numerous countries, of price-levels 
and money quantities, our search brings us to a conclu¬ 
sion from which there is no escape. We discover that there 
have been no large, sustained movements in prices with¬ 
out corresponding changes in the relation of the volume 
of money to the volume of goods. 


i8o 


MONEY 


Quantity of Money and Prices during the War 

Proposals to prevent a rise in the price-level by curbing 
the expansion of currency and bank credit are often op¬ 
posed on the ground that any restriction of the volume 
of money would also restrict production. This objection 
is well founded when employment and business activity 
are considerably below the maximum. As prices rise, how¬ 
ever, and the volume of unemployment is reduced, the 
time comes when a further increase of money and a fur¬ 
ther rise in prices do not increase production, but do in¬ 
crease the evils of inflation. Concerning this subject we 
shall have more to say in our closing chapter. For the 
present, we wish only to refer again to what we said, in 
Chapter V, concerning the effect in the United States of 
increasing money faster than goods during the World 
War. As long as increased bank credit enabled employers 
to put idle people and idle machinery to work, production 
was increased. The country soon reached the point, 
however, where it was employing virtually every man 
and every woman who was able and willing to work. At 
this point, competition among employers for materials 
and workers resulted in higher prices and wages and, 
consequently, in new demands on the banks for money. 
But bank credit created for the purpose of enabling 
somebody to take workers or orders away from some¬ 
body else did not increase production. 

Though, for these reasons, production was not increas¬ 
ing, consumers’ effective demand was increasing; for, 
with everybody at work at higher wages, the demand 
expressed in dollars was greater than ever before in the 
history of the country. In other words, wage-earners 
spent more dollars every day. To sustain production and 
expenditures at this level, banks were urged, in loyalty 


MONEY AND THE PRICE-LEVEL 


181 


to the country, to supply still more loans for the so-called 
“essential” industries, and for the purchase of Liberty 
Bonds and Government Certificates of Indebtedness. The 
banks were assisted in this process by the artificially 
low rediscount rates maintained by the Federal Reserve 
Banks. “ Borrow and buy bonds” was the slogan of many 
campaigners. Thus the fundamental factors of the eco¬ 
nomic situation during the War were a need for labor 
and a need for materials, neither of which could possibly 
be fully supplied, together with a dollar-demand for labor 
and materials that was sustained by an expanding sup¬ 
ply of bank credit. This increased purchasing power was 
thrown into markets in which the supplies of labor and 
materials had already reached their maximum limits. 
The inevitable result was a higher price-level. The close 
correlation between the increase in bank loans and the 
increase in retail food prices is shown in Figure 8. 13 

The influences which were thus working together to 
increase the volume and to decrease the value of money 
were not generally understood. “ It is clearly to the in¬ 
terests of the people,” said Labor , the weekly paper of the 
railroad brotherhoods, “that further credit should be 
created by the Federal Reserve Banks — to cheapen pro¬ 
duction costs, to facilitate transportation and marketing 
of farm products and thereby effectively reduce the costs 
of living” — at a time when an increased quantity of 
bank credit would have had exactly the opposite effect. 
An understanding of the quantity theory of money would 
have made this clear. 

This explanation of price fluctuations has been ques¬ 
tioned because, it is said, the decline in prices in 1920 
preceded the reduction in the volume of money. 14 That is 
true. In 1920, the fall in the price of most raw materials 
and finished products was initiated by a restriction of 


182 


MONEY 


credit which served notice on producers that they could 
not get more loans freely. Hence many, to insure solvency, 
kept idle funds. Some increased their loans, in order to 



have sufficient funds on hand in case other indebtedness 
had to be paid. To get cash, there was a great unloading 
of stocks on hand. The Ford Company, for example, 
liquidated its inventories throughout the country. Many 
other companies had to adopt an equally determined 































MONEY AND THE PRICE-LEVEL 


183 

liquidation policy because the banks had nearly reached 
the maximum limit of their credit facilities. Since the 
banks would not finance a further increase in prices, the 
upward movement of prices had to stop. Once the ad¬ 
vance was checked, the unloading of speculative holdings 
started the most precipitous decline in prices in the his¬ 
tory of the country; but it was not until later that there 
was a decrease in the money supply. In this particular 
case, then, the decline in prices preceded the decline in 
the volume of money. 

There have been other cases, however, in which a re¬ 
duction in money, with no corresponding reduction in 
goods, preceded and was the primary cause of a reduc¬ 
tion in prices. There have been still other cases in which 
the primary cause was increase in volume of trade, due 
to improvement in methods of production and distribu¬ 
tion of goods, with no corresponding increase in money. 
In some instances, increased prices are due to increased 
consumers’ demand that results from increased money. 
In other instances, an increase in prices is attributed to 
an increase in consumers’ demand when it is, in fact, only 
an increase in dealers’ demand. In still other instances, 
the bidding up of wages and material is followed by 
an increase of money in circulation, which dealers and 
manufacturers require in order to finance their operations 
at the higher scale of prices. The common error is the 
assumption that it is always prices that affect the volume 
of money, or vice versa. 13 As a matter of fact, it is some¬ 
times prices that affect the volume of money and some¬ 
times the volume of money that affects prices. Usually it 
is a combination of the two, reacting upon each other. 

Whether an increase in the volume of money initiates a 
rise in prices, or vice versa, matters relatively little. The 
main point of practical importance is that in no case 


MONEY 


184 

could a general advance in prices continue if it were not 
possible to increase the supply of money. If European 
countries, during the War and after, had taken this fact 
sufficiently into account, they might have prevented the 
human suffering due to unstable money which, as we ob¬ 
served in earlier chapters, surpassed the suffering directly 
due to the War itself. 


CHAPTER XI 

MONEY AND PRICES 

Setting aside all consideration of price-levels, we may 
now turn to the function of individual prices. For the 
purposes of this discussion, it is imperative that we keep 
clearly in mind the distinction made in the previous 
chapter. By individual prices we mean the exchange 
value of any commodity — say a ton of coal or a barrel 
of flour — in terms of dollars. By the general price-level, 
we mean a composite of all prices; that is to say, the cost 
of coal, flour and everything else at one time or place com¬ 
pared with the cost of the same things at another time or 
place. The paramount interest of every community in 
the price-level is clear and simple; it is summed up in the 
word “stability.” Where the price-level happens to be is 
of minor importance; the major need is that it should 
stay about where it is. The interest of the community in 
individual prices, which is not so obvious, is the subject 
of the following discussion. 

In the first page of our first chapter, we observed that 
nothing is more widely discussed to-day by thoughtful 
men and women than the recurrent plight of society in 
finding that there are millions of men who are able and 
eager to work, abundant tools to work with and materials 
to work upon, millions in need of goods, and no way of 
bringing the men, machines and materials into produc¬ 
tive relations to each other. We raised the question 
whether this is not mainly a price problem, since it is al¬ 
most exclusively by means of money that productive re¬ 
lationships are maintained, so far as they are maintained 


MONEY 


186 

at all, among men, machines and materials. We ob¬ 
served that human interests, ambitions and activities 
tend more and more to center around money; that eco¬ 
nomics, most profitably considered, is the science that 
deals with human affairs from the standpoint of price. 
It seems certain, therefore, that no one can solve the 
problem of periodic business depressions, or any other 
major economic problem, who has not first solved the 
problem of the meaning of price. 

The Economic Function of Price 

The economic function of price is to bring about the 
production and distribution of goods. Apart from “ cus¬ 
tomary prices” and conditions of monopoly, which re¬ 
quire separate discussion, prices have one major interest 
for society as a whole: prices do or they do not move 
goods. This concept is fundamental; we must hold fast 
to it. Pertinent questions do, indeed, arise at once. What 
kind of goods? How much of each kind? For what period 
of time? Distribution to whom? Such questions we may 
well set aside until we understand the basic proposition 
that the purpose of price is to move goods. And by mov¬ 
ing goods we mean, throughout our discussion, moving 
them at the rate of maximum, continuous productivity. 
When prices do not move goods, a period of depression 
ensues, with the familiar trend of falling prices, cancelled 
orders, frozen credits, closed factories, unemployment 
and passed dividends. Such a depression comes when¬ 
ever, following a marked decline in the prices of several 
important commodities, there is a falling-off in the buy¬ 
ing of goods from producers. Such a decline is the center 
and starting-point of all our difficulties. Any interference 
with the orderly and continuous movement of goods into 
consumption makes economic maladjustments the im- 


MONEY AND PRICES 


187 


portance of which has never been exaggerated, not even 
in the literature of social reform which has tendencies to¬ 
ward exaggeration. Production cannot long proceed at 
any given rate unless daily purchases take the goods 
away at the rate of production. To bring about that 
movement of goods is the function of price. 

Before continuing the discussion of this subject, it will 
be well for us to stop long enough to give further em¬ 
phasis to the fact that we are leaving out of consideration 
the exceedingly important cases in which monopoly and 
partial monopoly prevent prices from completely fulfill¬ 
ing their economic function. In the case of a monopoly, 
the competition of buyers does not meet the free compe¬ 
tition of producers. Therefore, the efforts of consumers 
to obtain goods, while they tend to drive up prices, do 
not have, necessarily, the compensating influence of stim¬ 
ulating increased production of these goods. Thus, the 
competition among buyers of aluminum, for example, 
does not affect the supply as does competition for a com¬ 
modity like cotton cloth that can be freely produced. 
Consequently, prices of monopoly-controlled commodi¬ 
ties may move goods, as government-controlled railroad 
rates may move trains, but without the economic effects 
that follow when the volume of production is determined 
by the free competition of buyers. Before proceeding 
with this complicated subject, we should also emphasize 
the fact that we are leaving many of its phases untouched; 
we are setting aside cases, for example, like that of gaso¬ 
line, in which consumers buy the total output, regardless 
of quality, and leave the producers no adequate incentive 
to improve their product. We are here concerned only 
with main tendencies. We are well aware of the fact that 
every reader will think of exceptions to the general rules, 
and the further fact that, however inexorable economic 


MONEY 


188 

law may be, it does not take effect instantaneously. “ It 
is not a policeman who arrests a criminal the moment he 
finds him committing a crime. It is a potter gradually 
shaping a plastic material to his will .” 1 

Right Prices 

When we speak of “ right prices,” as we frequently do, 
we are in danger of confusing moral and economic issues. 
There is a right temperature for baking bread, a right 
mixture of air and fuel for a gas engine, a right rainfall for 
growing wheat. In each of these cases something is scien¬ 
tifically right for a specific purpose, and its rightness can 
be proved by measurement but not by personal opinion. 
Similarly, in the science of economics, the extent to which 
prices function is a question of fact. It is confusing issues 
to call anything wrong because it fails to do what it is not 
designed to do. There is something wrong about a steam¬ 
roller for the purpose of pleasure riding, but there is noth¬ 
ing morally wrong. Prices may be wrong for the purpose 
of bringing relief to destitute families, but not morally 
wrong; prices are not charitable institutions. A true con¬ 
ception of the function of price underlies the common re¬ 
mark: “When prices are right, I will buy.” It would be 
even closer to the truth to say: “When I buy, prices are 
right.” The fact that people buy is, indeed, the proof 
that prices are right. When people do not buy, prices 
are wrong; wrong from the standpoint of the function of 
price, wrong solely because they do not bring about the 
production and exchange of goods. Business discovers that 
prices are right when goods are sold. There is no other 
test. It follows that prices cannot be right for business 
when they are wrong for consumers. Broadly speaking, 
and subject to the qualifications already given, the “ right¬ 
ness ” of prices consists in their capacity to move goods. 


MONEY AND PRICES 


189 

To attempt to fix prices in the interest of any other pur¬ 
pose is to have a part in defeating that purpose. If, as 
social reformers, we insist that prices or wages be fixed 
with reference to a given standard of living, we insist on an 
interference with economic forces that would defeat our 
aim by hindering the very movement of goods to consum¬ 
ers upon which the maintenance of any standard of living 
depends. If, as producers, we insist on keeping prices 
sufficiently high to yield a certain profit, we may forestall 
all profit by discouraging sales. If daily purchases are 
not sufficient to take up the daily production, prices are 
off; but nobody can tell how far off they are until, in the 
ordinary, widespread experience of the markets, prices 
are discovered that move the goods. 

If, as consumers, we attempt to reduce prices by arbi¬ 
trary restriction of profits, we may discourage produc¬ 
tion; and consumers cannot long benefit by restricted 
output, no matter what happens to prices. It is as im¬ 
portant for buyers as it is for sellers that business should 
proceed, year in and year out, at a profit: otherwise prices 
cannot continue to play their full part. Sometimes “sac¬ 
rifice sales” involve no sacrifice at all: sometimes the 
community makes the sacrifice. Ordinarily, if goods are 
moved at prices that injure necessary business concerns, 
the people as a whole pay the penalty: to have merchants 
really “selling out below cost” is not for the long-run 
interest of consumers. Once, however, we have boosted 
the level of prices and then fallen into the depths of de¬ 
pression, some stocks must be sold at a loss. In this case, 
prices that move goods in such a way as to start the idle 
wheels of industry are ultimately beneficial alike to buy¬ 
ers and to sellers. If, following the depression, the gen¬ 
eral price-level is again allowed to swing sharply upward, 
prices may move goods but presently may move them 


MONEY 


190 

into unusually large speculative holdings rather than 
into consumption. Such prices do not facilitate the long- 
run production and distribution of goods: they lead to 
another depression. All of which illustrates our intro¬ 
ductory remark that prices cannot continue to play 
their full part, with or without government regulation, 
on sharply fluctuating price-levels. And all of which will 
appear in a new light when we come to discuss the circuit 
flow of money from consumer back to consumer. 

Consumers control Production Schedules 

If the function of price is to move goods, the question 
arises, what goods? In answer to this question, Major 
Douglas and his numerous followers contend that the ex¬ 
isting system of production gives to the individual con¬ 
sumer “no say whatever as to the quantity, quality, or 
variety of ultimate products.” 2 We would say, on the 
contrary, that nobody but individual consumers have 
much to say about these matters. When they are left as 
free as possible from the restraints of monopoly and of 
government, they determine for the most part what is to 
be produced. Sellers may do their utmost by means of 
advertising and salesmanship to influence choice; but 
after they have done their utmost, the choice remains 
with the buyers. The prices they pay to-day are, in ef¬ 
fect, orders for future production. Leave them alone and 
they’ll come home, bringing the goods behind them. Peo¬ 
ple who spend money thus determine what will be pro¬ 
duced, because those who produce succeed only if they 
make what people with money to spend wish to buy. As a 
result, production which is not determined by the buyer 
necessarily remains small in volume. It is self-limiting. 
It is confined to goods produced by those who mistake the 
buyers’ wishes or carry on business for their own satisfac- 


MONEY AND PRICES 


191 

tion. A publisher may produce unsalable books because 
he misjudges demand, or he may publish profound techni¬ 
cal treatises at a predictable loss merely because he thinks 
they ought to be published. In either case, he is an excep¬ 
tion to the rule simply because his business is sterile; 
it does not yield the means of reproduction. As a rule, 
production must be governed by the wishes of the people 
who spend money. And they express their wishes — cast 
their votes, so to speak — by the very act of spending the 
money . 3 

When price thus plays its part freely, it answers the 
question how much of each commodity shall be pro¬ 
duced? When consumers are willing and able to pay a 
higher price for “ Pheasant Canton Crepe,” more is pro¬ 
duced ; when they are unwilling or unable to pay as much, 
less is produced — assuming that producers have ade¬ 
quate knowledge and that exceptional factors do not con¬ 
trol the situation, assumptions which we are all well 
aware are often contrary to fact. In the long run, how¬ 
ever, the prices at which goods are sold — not, let us ob¬ 
serve in passing, the prices at which goods are offered — 
regulate the scale of production of each commodity. 

This is a democratic means of determining what is to 
be produced. In the domain of commerce, every human 
being has a vote every time he makes a purchase. The 
suffrage is weighted, to be sure (a point we shall consider 
presently); but, at least, no one is disfranchised on ac¬ 
count of age, sex, race, religion, education, length of resi¬ 
dence or failure to register. Every day is election day. 
The buyer casts his vote wherever he goes. The votes are 
counted at once and with few errors; the cash register 
is as dependable as the ballot box. Those in charge of the 
polls are dependable, too, for it pays them to have prompt 
and accurate records of the voters’ choices. 


192 


MONEY 


With his dollars, the buyer votes for his representatives 
in production. He votes to continue in office those, and 
only those, who make the articles he buys. The mana¬ 
gers of industry are, therefore, a responsible ministry, 
much more amenable to public control, as a rule, than 
politicians. “Big Business” is not and cannot be the 
autocratic thing it is often said to be. Even the United 
States Steel Corporation must heed, from day to day, the 
votes of the buyers; it has no more to say about what it 
will produce than the village blacksmith. Publishers, too, 
must watch the election returns. Of three newspapers in 
a certain city, one will soon be obliged to suspend publica¬ 
tion. Which shall it be? The people will decide. Just as 
surely buyers are now deciding which manufacturers of 
automobiles are to be allowed to continue producing, and 
which of the two hundred or more makers of tires — five 
of whom are equipped to supply the total demand — are 
to go out of business. 

Competitive Business is Democratic 

Competitive business is more democratic than the most 
democratic of governments. Even after many genera¬ 
tions of struggle against autocracy, there is nothing com¬ 
parable in politics to the free and universal suffrage of 
buyers of goods. As a voter, the citizen often finds it im¬ 
possible to make his wishes effectively known. Most of 
his decisions are m,ade for him by politicians who have 
trouble in representing all their constituents, directly and 
accurately, even when they desire to do so; and who, 
when they desire to misrepresent them, have various 
means of concealing their action or shifting responsibil¬ 
ity for it. Many political votes count for nothing. It is 
estimated that forty-two per cent of the voters in New 
York City in the municipal election of 1921 were unable 


MONEY AND PRICES 


193 


to elect any representatives at all merely because they 
happened to live in certain districts. 4 Even when a citi¬ 
zen can make his vote count, he often has to choose 
among candidates, no one of whom he wants. The Liter¬ 
ary Digest straw ballot of 1920, the most extensive ever 
taken, indicated that neither Mr. Harding nor Mr. Cox 
was the first choice of one voter out of thirty; yet at the 
polls all voters had to choose between these two men 
or throw away their votes. For Mr. Hoover, who had 
240,468 first-choice votes in the straw ballot, the Repub¬ 
lican Convention did not cast a dozen votes, but nomi¬ 
nated Mr. Harding, who was the first choice of only 36,- 
795 voters. The whole wide range of industry now offers 
no apparent disregard of the wishes of consumers compar¬ 
able to this. The majority of seven million votes in the 
election of 1920 has been called “a clear mandate of the 
people against the League of Nations.” As a matter of 
fact, it was anything but clear, positively or negatively. 
When, on the other hand, seven million people buy 
Brown’s chewing gum, it is a clear mandate for future 
production. In 1920, if any one wanted a book in favor 
of the League of Nations, he bought it; but if he wanted 
to cast a vote in favor of a League of Nations, he could 
find no way of doing it. Too many issues were involved. 
Slow, clumsy, indirect, and uncertain, as a rule, are the 
available means for expressing the voters’ political de¬ 
sires. In short, the consumer’s dollar, in the economic 
sense, is always an effective demand; his political vote is 
often far from being an effective demand. 

As a spender of money, the voter ordinarily has no 
difficulty in taking direct action in accord with his wishes. 
If he wants to buy a copy of Brown’s Magazine, he does 
not find himself thwarted by such complications that he 
is forced in the end to choose between Snappy Tales and 


194 


MONEY 


The Frantic Weekly. If he wants a Brown typewriter, he 
does not have to select, on the basis of a platform of 
vague promises, a dealer to represent him in the markets, 
only to find, in the fullness of time, when the dealer and 
his fellow dealers get around to it, that he has to put up 
with a compromise machine and pay the bill, whether or 
not he wants that machine. On the contrary, he places 
his order directly with the Brown Company. Within a 
few hours, or at most a few days, he gets exactly what he 
has ordered. Almost as promptly, his action plays its 
part in determining the future production of typewriters. 
In fact, it is his vote for this particular commodity, plus 
all the other dollar-votes he casts, plus all the dollar- 
votes of all other buyers, that determine the production- 
schedule of the world. Every dollar counts; minorities do 
not throw away their votes; and scarcely any one can re¬ 
frain from voting. Thus, in ordinary times, consumers 
make daily use of a system of proportional representation 
that is more nearly perfect than any of the systems 
which idealists have proposed for political elections. 

The System is not without Defects 

In so far as the system is ineffective in times of peace, 
it is because producers, through ignorance of facts that 
are now beyond the reach of private enterprize, or error 
in judging the permanence of the market, miscalculate 
the nature and extent of the demands of buyers, with 
resultant “over-production” and “under-production.” 
Certainly the system can be made more effective, for it 
will not be difficult to inform producers, more promptly 
and more accurately than hitherto, concerning the trend 
of effective demand in relation to stocks on hand and 
under way. By means of this information-service, and by 
other means to be suggested in later chapters, rather 


MONEY AND PRICES 


195 


than by means of price-control, the Government will find 
its opportunity to aid in stabilizing production. But, 
even when producers are fully informed, have we any 
reason to rest assured that they will be governed by the 
wishes of consumers? Certainly we have, for under a 
competitive system in which men must sell goods at a 
profit, or go out of business, there is ordinarily a quick 
response to consumers’ demand. 

In time of war, however, the aim of production is no 
longer the immediate satisfaction of the individual wishes 
of those who have money to spend. The sole aim is win¬ 
ning the war. This radical and sudden change from an 
individual aim to a collective aim demands a radical and 
sudden change in the method of deciding what shall be 
produced. The two aims are in sharp conflict. It does 
not help matters to stop to consider why the aims ought 
to be identical: the conflict remains. Because of this con¬ 
flict, it is stupid to talk about “business as usual.” When 
war strikes, nothing in the economic world is, or can be, 
“as usual.” In ordinary times, as we have explained at 
length, the greatest possible satisfaction is attained by 
allowing each spender of money, unrestrained by the Gov¬ 
ernment, to have his part in determining what shall be 
produced; and he plays his part by bidding for what he 
wants in the open market. In war time, however, this 
method prevents the state from mobilizing its resources, 
because the very money that the Government spends 
creates competitors for what the Government wants, 
without increasing the supply. So the state undertakes 
to destroy or divert ordinary economic forces. Once the 
state has suspended the operation of these forces by ar¬ 
bitrarily fixing the price of coal, for example, or the 
wages of train men, the whole intricate, established sys¬ 
tem of relationships is broken down. We cannot do “bus- 


196 


MONEY 


iness as usual” in a world in which price is not allowed to 
serve its usual function. 

The People decide how much shall be produced 

Prices are not right, we have said, unless they stimu¬ 
late production at maximum capacity. But what do we 
mean by maximum production? Evidently no country 
has ever produced all that it could produce. Estimates of 
the capacity of the United States vary considerably, but 
all agree that the country has at no time reached its 
possibilities. How much should a country produce? Full 
consideration of that question would take us far afield 
into disputed problems of philosophy. Everybody will 
agree, however, that if the aim of production is the satis¬ 
faction of human wants, production defeats its own pur¬ 
pose if it involves sacrifices which more than offset the 
enjoyment of the goods produced. When, therefore, we 
say that right prices are those which stimulate a country 
to its maximum, continuous output, we mean the maxi¬ 
mum production which is consistent with human satis¬ 
faction. Where the line should be drawn is not a pressing 
problem, nor is it likely to become one, for human nature 
is sufficiently protected against excessive sacrifice of this 
kind. During the World War, at certain blast furnaces 
in the South, many negroes, as soon as their wages were 
doubled, worked only half as many days as formerly. 
They had no difficulty in balancing, to their own satisfac¬ 
tion, their pain as laborers and their pleasure as consum¬ 
ers. Human beings everywhere, taken as a whole and 
in the long run, except when price fluctuations and un¬ 
employment prevent, adjust their efforts as producers to 
the maximum possibilities of their pleasure as consumers. 
No other means of effecting that adjustment could be so 
prompt, so sensitive and so sure as right prices — the 



MONEY AND PRICES 


197 


right wages, on the one hand, to induce people to make 
their efforts as producers; and the right prices, on the other 
hand, to induce them to part with their money as con¬ 
sumers. Thus the people themselves decide, through 
innumerable choices made daily on the basis of wages 
and prices, how much a country ought to produce, pro¬ 
vided — and this is a proviso of such importance that we 
shall make it the central theme of the rest of the book — 
provided enough money flows into consumers’ hands to 
enable them to buy, at the current price-level, the com¬ 
modities that are produced. 

By controlling Prices the Buyer controls Production 

If the buyer is to control production, he cannot escape 
the responsibility for controlling prices; for it is only 
through fixing prices that he can fix production schedules. 
It is the buyer, not the seller, who makes the final decision 
as to price. The only price the seller can fix is the price 
at which goods are offered; the buyer fixes the price at 
which they are sold. This may sound like nonsense to a 
man who has just bought a hat. When he entered the 
shop, he found the hat already priced, and priced too high 
to suit him; yet he had to pay the price or leave the hat. 
Nevertheless, he and all other buyers, exercising their 
freedom of choice in the open market, and bidding for 
the same goods, fixed the price at which that hat was sold. 
Naturally, no price can be satisfactory to buyers in¬ 
dividually, as long as collectively they desire more hats 
than there are hats in existence. Whenever anything is 
sufficiently scarce and sufficiently desired to command 
any price at all, more than one man will want it. This 
antagonism of interests is one of the most fundamental of 
social facts. It cannot be overcome by price fixing, or 
currency measures, or government control of distribution, 
or any other program whatever. 


MONEY 


198 

The hatter is under no delusion concerning his own 
control of prices. He knows that in filling out his price- 
tags, he must guess right concerning the action of buyers 
or guess again. His own customers will let him know 
when he guesses right. Meantime, in each shoe store and 
each clothing store, the customers are likewise informing 
each merchant what his selling prices must be. There is 
no other way of accounting for the fact that buyers on 
Fifth Avenue pay fifty dollars for a coat, while buyers 
two blocks east pay only thirty dollars for the same ar¬ 
ticle. The facts of the situation are such that no price- 
agreement among merchants could be made effective. 
The buyer holds the strategic position. 

An industrial engineer, H. L. Gantt, is said to have 
estimated the productive efficiency of the United States 
in 1919 at about five per cent, — presumably in com¬ 
parison with the conceivable production of a far different 
race of human beings. “He was under no delusion as to 
the cause of this,” says C. H. Douglas. “ It was because it 
did not pay those in control of the industrial process 
to make it any higher, not, be it noted, because those 
operating it did not know how.” 5 This is a widespread 
belief. Managers of industry are constantly charged with 
limiting production in order to maintain prices, and thus 
make larger net profits. Those who make the charge 
overlook the fact that it is only under the exceptional 
conditions of complete monopoly, or agreements that 
bind all the producers of a given commodity, that out¬ 
put is subject to such control. Where competition pre¬ 
vails, the profits of the individual producer depend, as a 
rule, upon his industrial efficiency. He has no incentive 
to limit his output. The net result is that producers as a 
whole are constantly striving to produce more goods at 
the same or lower costs : since they must compete with 


MONEY AND PRICES 


199 


other producers for the same customers, they are con¬ 
stantly striving to be in a position to sell, if buyers insist, 
at lower prices than any one else. 

The strategic position of the buyer is due to the sub¬ 
stitution of money for barter. The real facts are obscured 
by traditional discussions of price which draw their il¬ 
lustrations from a primitive state of barter, or school boys 
swapping jack-knives, or an auction sale in the country, 
or a tourist and a street vendor in Italy haggling over 
the price of a string of beads. Such trading conditions give 
imperfect ideas of price-determination in modern mar¬ 
kets. Nowadays, most prices are not reached through 
barter, or auction, or haggling. The introduction of 
money and banks, followed by the development of large- 
scale selling agencies and telegraphic connections among 
the markets of the world, has put the buyer in a new 
position. Because of the three choices which go with 
his money — as to time and place of spending and as 
to goods — the buyer ordinarily has the advantage of 
position. 6 The seller, on the other hand, has but one 
choice — namely, to sell for whatever price the buyer 
decides to pay for his goods, or keep the goods. And this 
is not much of a choice, as keeping the goods usually 
invites bankruptcy. 

Fourteen years ago, in the automatic bargain basement 
of a large department store, customers were invited to 
fix their own prices. The announcement was made that 
all goods remaining unsold after twelve selling days 
would be reduced in price twenty-five per cent; after 
eighteen days, fifty per cent; after twenty-four days, 
seventy-five per cent. After thirty days, all goods re¬ 
maining unsold were to be given away. The failure of the 
plan was freely predicted. Surely, the critics said, most 
people would wait a few days in order to take advantage 


200 


MONEY 


of the automatic price-reductions. But the critics over¬ 
looked the fact that in the automatic basement, as well as 
in the rest of the store, buyers would compete with each 
other for the same goods; and the individual buyer could 
wait for lower prices only at the risk of having others get 
the goods. He did not wait: during a representative year 
he bought 88.4 per cent of the merchandise at the original 
price. 

Even the largest corporations, in many instances, 
could not reduce the retail selling-price of their products, 
no matter how much they might desire to do so. The 
United States Steel Corporation may be as good a case 
in point as any other, since it is often cited as an ex¬ 
ample of autocratic control of prices. As a matter of fact, 
when the Steel Corporation pegged the price of its pig- 
iron at thirty-eight dollars a ton, at a time when buyers 
were ready to pay forty-two dollars, there was no con¬ 
sequent reduction to consumers in the prices of iron 
products. Buyers of pig-iron took all they could get from 
the Steel Corporation at the lower price, and for the rest 
of their requirements paid a higher price to the independ¬ 
ent producers. The buyers, however, were able to base 
the prices of everything they made out of this raw mate¬ 
rial on forty-two dollar pig-iron because the consumers 
were able and willing to pay these prices. Consequently, 
whatever the buyers of pig-iron saved by the action of 
the Steel Corporation in keeping down its price, meant 
no saving whatever to the ultimate consumers who fixed 
the final sale price. 

Because of the failure of the buyer to understand the 
function of price and his part in the sale of goods, he is 
constantly trying to place on somebody else the respon¬ 
sibility for the cost of living. That is to say — though 
he would not say it in this way — he would like to pre- 


MONEY AND PRICES 


201 


vent others from buying what he wants to buy. This 
spring he desires the latest shade of tanned shoes; noth¬ 
ing else will do. The price, however, seems to him exor¬ 
bitant. He overlooks the fact that he, himself, in exer¬ 
cising his consumer’s privilege of directing the produc¬ 
tion of shoes, has boosted the price of the style of shoes 
he chooses. He insists on the personal right to walk 
into the butcher shop and select his cut of beef, but 
he protests against the high price. He does not perceive 
that he, in conjunction with all other buyers of beef, has 
made the price of those selected cuts three times as high 
as the price of certain poorer cuts. Who is to get the 
better cuts? What price is to be paid? Here are two ways 
of asking the same question. Under the prevailing sys¬ 
tem of price-bidding, the consumers themselves decide. 
And they are accustomed to no other method of decision. 

The question arises here whether human satisfactions 
would not be larger ultimately if industry were directed 
by means of price-control so as to satisfy a higher level of 
tastes. Would not the reduced production of “comic 
supplements” — which, as Dr. Crothers says, throw such 
a lurid light upon our boasted sense of humor — even¬ 
tually mean increased satisfaction to the people through 
the diversion of productive powers to higher forms of art? 
Consider, as further examples, hair-dyes, high-heeled 
shoes, pleasure automobiles, bill-boards, headache pow¬ 
ders and free verse. Should not the prices of these com¬ 
modities be made for the purpose of curbing their pro¬ 
duction? On first thought, the idea may seem excellent; 
but on second thought, the practical and perplexing 
question arises, who is to decide what is best for the peo¬ 
ple, if they are not to decide for themselves? And that is 
not the only difficulty, for even if autocratic control were 
desirable, attempts to lift the level of human tastes by 


202 


MONEY 


interference with prices would be costly and ineffective. 
Other methods are preferable. The function of price is 
economic, not moral or educational. Prices have done 
their full part in production when they have brought to 
the market what the people actually want who pay the 
prices. If the resources of the country were employed to 
put upon the market what somebody thought the people 
ought to want, one of the certain results would be the 
decreased satisfaction of the people. It would not matter 
how well-meaning that 1 ‘somebody” might be. No one — 
teacher, congressman, minister, or social worker — whose 
effort is directed toward lifting the desires of people to a 
higher level, need be concerned about the economic prob¬ 
lem of satisfying those new wants. As soon as wants are 
really changed, the changes will be recorded and measured 
by dollar-votes, cast in the ordinary round of daily 
marketing. Corresponding changes in production will 
follow much more rapidly than such changes could be 
brought about in any other way than through the ordi¬ 
nary, direct influence of price. 

Price Control of Production is Most Effective 

The objection will be raised that the consumers’ 
franchise, with its property qualification, is undemocratic: 
it is heavily weighted, like the political franchise in 
Prussia before the War. In other words, the influence 
that any one consumer can bring to bear upon produc¬ 
tion varies directly with the amount of money he has to 
spend. True; and it may be that, as a result, human pro¬ 
ductive powers are not directed to yield the highest 
possible sum total of human satisfactions. But the fault 
is not with distribution according to price. We shall 
clarify our thought if we avoid confusing two distinct 
questions. One question is this: Who is to decide what 


MONEY AND PRICES 


203 


shall be produced in exchange for the dollars of each pur¬ 
chaser? The other question is this: How shall the total 
number of dollars be apportioned among the purchasers? 
They can be apportioned equally (and can thus, accord¬ 
ing to some theories, direct production to the maximum 
satisfaction of society as a whole) only under complete 
communism. But the point we are here stressing is that, 
no matter how the total purchasing power is apportioned, 
the fact remains that the established methods of deter¬ 
mining prices and production — though not perfect — 
are extraordinarily effective methods for guaranteeing 
each buyer exactly what he wants up to the limit of his 
dollars. 

Even if the total purchasing power were distributed 
equally, consumers would still want to control produc¬ 
tion. Let the reader try the matter out for himself — 
no matter who he is, no matter how rich or how poor, no 
matter how conservative or how radical. To whom would 
he be willing to turn over the decision as to what should 
be produced as his share of the total industrial out¬ 
put? To a city council? To bank directors? To labor 
union officers? To Congress? To the Federal Council of 
Churches? Which of his choices would he be disposed to 
delegate? His choice of food? Amusements? Books? Ci¬ 
gars? There is but one answer. Even if his claim upon 
the total output were precisely the same as that of every 
other consumer, he would still prefer to exercise the free¬ 
dom of personal choice; and the most effective way to 
register his choice would still be through dollar-votes. 
He does not need the recent tragic experience of Russia 
to convince him that slow and bungling would be the 
best efforts in his behalf of even the most devoted official 
directors of production. 7 

In the industrial world, fortunately, we are not forced 


204 


MONEY 


to put up with such an inefficient method of apportioning 
control. Not that the prevailing method of deciding 
what is to be produced yields exactly what is of most 
worth. Some of our conspicuous wasters cast dollar- 
votes in production out of proportion either to their 
intelligence or to their service to society. It may be that 
much progress must be made in the distribution of 
purchasing power before our dollar-votes will keep the 
machinery of the world at work turning out in all cases 
exactly what is best for the world. But, again, we must 
remind ourselves that the function of price is not ethical, 
but economic. We cannot bring about a more equitable 
distribution of the purchasing power through arbitrary 
price control. Whatever the defects of our economic order 
— and their seriousness we noted at the outset — the 
fact remains that our weighted dollar-franchise expresses 
the economic desires of the world much more quickly and 
accurately than our unweighted, democratic, universal 
suffrage expresses the political desires of the world. 

Prices are a Measure, not a Cause, of Trouble 

It follows that prices are a measure of trouble, not a 
cause of trouble. That is why (excepting always, as we 
did at the outset, cases in which competition is prevented 
from having its full effect) it is useless to attempt to 
change the real cost of living by attacking prices. The 
people of the Miami district gained nothing by finding 
fault with the rod that measured the rising waters at 
Dayton: they protected the city from floods only by 
going back to the sources of trouble and making provision 
for an even flow of water. When we find fault with the 
prices at which goods are sold, or indiscriminately con¬ 
demn merchants as “profiteers,” or blame producers as a 
class for raising the cost of living, or banks for making 


MONEY AND PRICES 


205 


money dear, or household servants for the wages they 
obtain, we are attacking signs. We are trying to reduce 
the temperature by smashing the thermometer. 

That is what governments have done, for the most 
part, whenever they have tried to reduce the real cost 
of living by prosecuting “profiteers.” That is what 
Federal agents did when they took to task the restaurant 
proprietors of Boston. That is what the Committee of 
Manufacturers and Merchants on Federal Taxation tried 
to do through Government regulation of ground rents. 
That is all we can say for the attacks on retail clothiers 
and retail shoe dealers made by the Department of 
Justice at Washington. That, again, is what Representa¬ 
tive Herrick proposes to do by means of his bill for the 
standardization of all wages and all prices, and Senator 
Ladd by means of his bill “to reduce the rate of interest 
on loans.” 8 And that is precisely what New York City 
did in 1921 by carrying on a campaign against high rents 
in general, and then making the further mistake of abat¬ 
ing taxes on new buildings in an attempt to repair the dam¬ 
age done by its initial interference with economic forces. 
These are all misguided efforts. For the most part, 
“profiteers” do not make high prices: high prices make 
“profiteers.” And buyers make the high prices. As 
Gustav Cassel said in his memorandum to the League of 
Nations, “the popular idea that a rise of prices can be 
prevented by legislation enacting maximum prices and 
inflicting severe punishments on speculators and profit¬ 
eers while the country is insistently flooded with fresh 
money is a fallacy which it is very important to get 
routed out.” 9 

With what we have just said about the folly of govern¬ 
ment regulation of prices, many will not agree. Even so, 
we hope that they will reconsider the question in connec- 


Individual 

Prices 

Dispersing from 
1913 



'lard .barley 
iron bars, coke 

■tin plate.sicins 

b 0 a atT h0gS 
« glli-eggs hay 

lime, silk 
'beef, lead 
■pork, cement 
-butter, silver 
copper 
attle 


petroleum 
lumber 
anth. coal 
hides 


coff& 


rubber 


73 74 75 76 77 18 

Figure 9. Showing the Wide Dispersion of the Price Movements 
of 36 Commodities from 1913 to 1918 

The vertical line, marked “5%,” helps the eye to estimate the fluctua¬ 
tions. With the aid of this measuring rod, it is easy to see, for example, 
that in 1917 coffee was about five per cent higher in price than rubber, 
and petroleum about twenty per cent higher than coffee. 

Figures 9 and 10 are taken from The Making of Index Numbers , by 
Irving Fisher, Number One of the Poliak Publications. 









rubbtr 



Individual 

Quantities 

Dispersing from 


913 


skins 


copper 

tin plate 

[Cattle 

wool 

'■iron bars 
beef 
pig tin 
petroleum 
barley. s n k 

ac °Poats 
:offee 
lead 

Z r c«n.wj? n 

Zycofof 

heat, lard 
hides 
silver 

dumber 

lime 

cement 

white lead 

mutton 

steel 


73 74 75 76 77 78 

Figure io. Showing the Wide Variations in the Quantities 
Marketed of the same 36 Commodities 


















208 


MONEY 


tion with what we have to say later on about Money as 
Suspended Purchasing Power and Money in Relation to 
Goods, for the discussions in these chapters give a new 
basis for the traditional objections to government regula¬ 
tion of prices. At this point, we suggest that those who 
object to our conclusions examine Figure 9, which shows 
the price movements of thirty-six commodities from 1913 
to 1918, and Figure 10, which shows the changes in the 
quantities marketed of these same commodities. Now, 
the relation to each other of these prices and the relation 
to each other of these quantities were determined for the 
most part, as we have shown, by buyers in the ordinary, 
daily course of marketing. If these are not the price 
movements which should have taken place since 1913? 
the question arises, what should have been the price dis¬ 
persion ? How could any one figure out in advance what 
ought to be the relations among these prices? Evidently, 
no one could decide what these thirty-six prices ought to 
be without deciding what thousands of other prices ought 
to be; for there must be a right relation of every price 
movement to every other price movement. In the face of 
these difficulties, how could even the ablest of Federal 
agencies achieve anything but confusion? As a matter of 
fact, in order to fix prices that would regulate production 
schedules and distribute the products as closely in accord 
with the desires of the people as the prevailing system of 
price-bidding, the Government would have to devise 
some means of measuring the almost infinite number of 
daily changes in the needs and desires of millions of peo¬ 
ple, and also some means of measuring the almost infinite 
number of daily changes in the goods offered by the mar¬ 
kets of the world for satisfying these changing needs and 
desires. These measurements are made at present with 
amazing precision by millions of buyers and sellers: no 
government is equal to such a task. 


MONEY AND PRICES 


209 


Although buyers have little to do with initiating 
changes in the general price-level, they have nearly every¬ 
thing to do with the relation of prices to each other on a 
given price-level. Did the price of sugar seem outra¬ 
geously high at twenty-five cents a pound? Buyers put 
the price where it was in relation to other prices. It was 
as difficult to prevent them from hoarding sugar at twenty- 
five cents as it was later on to persuade them to buy it at 
five cents. As soon as a strike against clothing dealers was 
organized in the form of “overalls brigades,” did the price 
of overalls go up? Buyers, not the sellers, were responsi¬ 
ble. Do the rents of apartment houses on Manhattan Is¬ 
land yield unreasonable profits? Buyers have put up these 
rents by seeking in such large numbers to house them¬ 
selves on that small part of the world’s surface. Else¬ 
where buyers have leased apartments at rents which do 
not pay the taxes on the property. If the landlords are 
“profiteering” in the one case, the tenants are “profiteer¬ 
ing” in the other. Between the year 1914 and July, 1920, 
according to the Aberthaw Index, the cost of constructing 
a standard, reenforced, concrete building rose from 100 
to 265. The higher construction costs resulted in a rela¬ 
tive scarcity of buildings, whereupon those who wanted 
buildings boosted the rent, much as buyers bid up the 
price of hay when the hay crop is poor. During the same 
period, owners of Ford cars, finding that they had risen 
in value, did not refuse to profit from a combination of 
causes very much like that which resulted in higher rents. 
As a matter of fact, buyer and seller, landlord and tenant 
— and everybody else, for the most part, including those 
who condemn “profiteers” — are all actuated by the 
same motives. 

This procedure — cold, calculating, even cruel, as it 
seems to many people — is, in reality, not only defensible, 


210 


MONEY 


but beneficent. Variations from this attitude toward 
prices are exceptional, and necessarily so. Where every 
one obtains as much as he can honestly and lawfully 
obtain for his goods — giving due consideration to long- 
run profits — the world is likely to have the largest 
volume of goods to distribute, the largest social dividend. 
In this connection, as always in the midst of economic 
problems that seem perplexing, we have to remind our¬ 
selves that we cannot do a sleight-of-hand trick with 
prices and, like magicians, draw forth a stream of com¬ 
modities out of an empty hat. The world can consume 
only what it produces; price can do no more than its full 
part in making that production large and continuous. 
Price cannot play that part unless it is the recognized rule 
that people labor and produce for as much money as they 
can obtain for their services and their goods. Exceptions 
We noted at the outset in the case of monopolies. Other 
exceptions there may be within very narrow limits, and 
some of these no doubt are coupled with high motives; 
but the rule remains. Mixing business and philanthropy 
is good for neither. The theories of price and of produc¬ 
tion here presented are consistent with the highest social 
ideals. There are many causes for the “high cost of liv¬ 
ing,” but the fact that people, as a rule, take as much 
money as buyers will pay is not even one of the minor 
causes. 

Conclusion 

We must conclude that prices completely serve their 
economic purpose when they are a sufficient incentive to 
the maximum production that is continuously possible 
and desirable, and that they continue to be such an in¬ 
centive as long as the money spent daily in consumption 
buys this maximum output. In other words, prices serve 


MONEY AND PRICES 


211 


their purposes when they are in the right relation to the 
productive capacity of the country, on the one hand, and 
to the money in circulation on the other hand. This re¬ 
lationship is maintained on a stable price-level as long as 
buyers are left alone to determine prices and production 
in free markets, and producers and distributors have 
sufficient knowledge of what is going on. First of all, 
then, we must do our utmost — which is more than any 
nation has ever done — to curb extreme fluctuations in 
the purchasing power of the dollar, for shifts in the price- 
level interfere with the salutary functioning of prices. 
Beyond that we must leave buyers as free as possible to 
determine by their own dollar-votes the relation of in¬ 
dividual prices to each other; and we must furnish pro¬ 
ducers with timely information upon which to lay out 
production schedules. Then prices will do the utmost 
good they can be made to do, by bringing about the con¬ 
tinuous production and distribution of goods on a suffi¬ 
cient scale, in the case of each commodity, to represent 
the personal desires of each of those who cast the dollar- 
votes. 


i 


CHAPTER XII 

MONEY AS SUSPENDED PURCHASING POWER . 

The superiority of money over barter as a mere matter of 
convenience helps to account for the vast and intricate 
development of the world’s work; 1 but it accounts in no 
way whatever for the periodic interruptions of the world’s 
work. Until we know the precise differences between 
trade by barter and trade by money, we cannot know 
precisely what features of our present economic order are 
due to the adoption of a medium of exchange. And until 
we know that, we cannot conjecture to what extent and by 
what methods it may be possible in the future to adapt 
the use of money to the interests of sustained production. 
Although a study of barter does not explain what goes 
on in modern commerce, it may help to explain what does 
not go on in modern commerce. It may help us to find 
out whether the change from a barter economy to a 
money economy has at times prevented, as at most times 
it certainly has facilitated, the exchange of goods. 

For these purposes, the one meaningful characteristic 
of trade by barter is that the demand for goods always 
equals the supply of goods. This aspect of a barter econ¬ 
omy, perhaps because it is so obvious, appears to have 
been overlooked entirely in the past or mentioned with¬ 
out apparent realization of its significance. Yet it may be 
that no other aspect can throw more light on the causes of 
business depressions. An analysis of primitive methods 
of exchange may illuminate our current problems if we 
focus our attention on the fact that, where goods are ex¬ 
changed only for goods, there can be no addition to the 


AS SUSPENDED PURCHASING POWER 213 

effective demand without an exactly equivalent addition 
to the supply. In other words, a barter trader cannot take 
anything away from the world’s stock of goods without 
adding something which at that moment in the very 
process of exchange becomes an exact equivalent. 

The Perfect Barter Balance of Supply and Demand 

This perfect barter balance of supply and demand is il¬ 
lustrated by every exchange of goods for goods. Where 
there is no medium of exchange, a bear-skin in the hands 
of a trader becomes an effective economic demand only 
in the presence of something, a sack of corn let us say, 
which another trader is willing to give for the bear-skin, 
and which the owner of the bear-skin is willing to accept. 
If a man has a sick horse, for which nobody is willing to 
give anything, the horse is a zero quantity both as supply 
and as demand. As soon as the horse recovers to such an 
extent that a trader is willing to give a certain goat for it, 
and the owner trades the horse for the goat, the horse 
adds to the market a demand exactly equivalent to the 
value of that goat and a supply measured also by the 
value of the goat. In such trading the measure of the de¬ 
mand is the supply. Demand and supply are one and the 
same thing, looked at from different view points. There 
is accordingly an exact and inevitable balance. The trans¬ 
actions are virtually all “spot”; the barter trader who 
parts with his bear-skin demands and receives at once a 
sack of corn. The transaction is over. There is no after- 
math of suspended purchasing power left hanging over all 
future transactions, to be used nobody knows when , or 
where or for what goods . 

But when a bear-skin is sold for money, this money 
may or may not be used to purchase a sack of corn. The 
exchange of goods is interrupted; indeed, it may never 


214 


MONEY 


take place. For money is suspended purchasing power. 
For that reason, the sale of a bear-skin for money at once 
gives rise to the new possibility of a demand without sup¬ 
ply or a supply without demand. 

This is a consequence of the use of money which many 
writers do not take into account: they reason as though 
all sales were still barter transactions and all exchanges 
were immediately effected. They adjure us to “think in 
terms of goods.” “Trade, after all,” says one of our bank 
presidents, “is but a perfected system of barter, in which 
money serves as a term of comparison.” 2 Bilgram and 
Levy tell us that “recourse has long been had to a proc¬ 
ess of complex barter through some medium of ex¬ 
change,” but “the final outcome is nothing more than the 
exchange of goods for goods.” 3 Lettice Fisher agrees. 
“All trade,” she says, “is, of course, barter.” 4 “What al¬ 
ways ultimately takes place,” says Sir Lancelot Hare, 
“is the exchange of goods or services for goods or serv¬ 
ices.” 5 “Trade is still barter,” adds George W. Gough, 
“and the young economist must do exactly as Solomon 
and Hiram did — think in goods.” 6 The trouble is that if 
he thinks only in goods, he entirely overlooks the un¬ 
balancing of supply and demand that money makes 
possible. 

It is misleading to consider the exchange of goods for 
money as only half a transaction. It is, in every case, a 
completed transaction. Money is final payment. Money 
does not, as MacLeod and others have said, represent the 
indebtedness of society at large. There is no obligation on 
the part of society or of any individual to give anything 
in particular for money. The receiver of the money takes 
his chances. Sometimes these chances are negligible and 
are so considered. At other times, the exchange value of 
money is so uncertain that many traders refuse to accept 


AS SUSPENDED PURCHASING POWER 215 

it at all. But at all times, when money is accepted for 
goods or for services, the exchange is completed. 

Thinking of modern trade as though it were barter 
trade is so misleading and yet so widely recommended 
that it will pay us to consider other expressions of this 
orthodox view. “ There is always a demand for this ad¬ 
ditional product,” says one writer, “because the addi¬ 
tion to society’s income enables society to pay the ad¬ 
ditional workers or machines or organizers. . . . What we 
call * Supply ’ and 1 Demand ’ are the same things looked 
at from the different standpoints of consumer and pro¬ 
ducer.” 7 “Supply and Demand,” says another writer, 
“are only phases of the same economic conditions and it 
is hardly conceivable that they can ever be anything but 
equal.” 8 All this, as we have pointed out, is true in a 
barter economy. All this would be true to-day, if each 
worker took to market with him as his “demand” ex¬ 
actly what he had produced, nothing more and nothing 
less. In other words, it would be true of a money economy 
if the demand which daily reached the markets in dollars 
were precisely the same and remained the same as the 
supply of goods, reckoned in dollars at the current prices, 
which daily reached the same markets. But rarely does 
this happen. 

The Unbalancing of Supply and Demand in Modem Markets 

A similar error appears to be involved in the following 
statement from the monthly letter of a New York bank: 
“It cannot be too strongly emphasized that there is no 
other market for products, and no way by which any 
group can buy the products of others but by selling its 
own.” 9 Again, this is true of barter markets. But, for 
reasons set forth in the tenth chapter, it is not true of 
modern markets in any given year; and a year, let us re- 


216 


MONEY 


peat, is time enough in which to bring on a business crisis. 
Even in the long run, it is not strictly true, for it does not 
take account of purchasing power which speculators and 
governments offer for goods, without bringing to the 
markets a corresponding supply of goods. Nor does it 
take account of purchasing power created, in the form of 
bank credit, for the express purpose of enabling an owner 
of goods to withhold them from the market. 

‘‘Credit,” says Oswald St. Clair, ‘‘has not directly af¬ 
fected prices simply because it has expanded with the ex¬ 
pansion of the transactions which gave rise to it and upon 
which it is based.” 10 The same idea underlies the entire 
volume by Percy and Albert Wallis. “Any increase of 
this balance [of bank deposits],” they assert, “means an 
increase in the total goods and services to the credit of the 
community, but does not raise the price of those goods or 
services in any way. ... As the extent of such credit de¬ 
pends strictly upon the value of the goods passed on to 
the social capital, it is not obvious that bankers can ex¬ 
tend or contract such credit or inflate the currency by an 
increase of deposits.” 11 Now, unfortunately, the credit 
created does not depend strictly upon the value of the 
goods. Always it depends on somebody’s judgment of 
probable future value. Sometimes, indeed, it depends 
upon the problematical and merely estimated value of 
goods which may or may not be transferred or even pro¬ 
duced.” “The actual transfer of goods,” says Professor 
Laughlin, ‘‘ is the essential part of the credit operation.” 12 
Clearly, it is the essential part of a barter transaction; but 
the essential part of a credit operation is the transfer of 
purchasing power. 

Nevertheless, our banking system is predicated on the 
conviction that there can be no inflation as long as the 
“gold standard” is maintained and the volume of money 


AS SUSPENDED PURCHASING POWER 217 

is increased in response to what are regarded as the legiti¬ 
mate needs of business. “As long as Federal Reserve 
notes are redeemable in gold,” said the Chairman of the 
Federal Reserve Board, “and the required reserves are 
maintained, it is difficult to see how there can be any in¬ 
flation of the currency growing out of the issue of Federal 
Reserve Notes.” 13 Not to present these quotations at 
needless length, we may close the list with the following 
admirable statement of the accepted doctrine: “As long 
as reserve balances are created and circulation is issued 
only against self-liquidating paper, which represents 
things in course of production, and as long as this process 
is kept within a safe relation to gold, there may be more or 
less acute banking expansion, but there would not be any 
cause to call it inflation.” It is true that issues of money 
against what is called self-liquidating paper need cause 
no inflation, if by that term we mean an expansion of 
money that results in an abandoned gold standard and 
depreciated paper money. But inflation, thus defined, is 
not the only issue in the United States. As we observed 
in previous chapters, it is increases in the volume of gold- 
supported money accompanied by a rising price-level 
with which we are immediately concerned. And this con¬ 
dition usually results if new issues of Federal Reserve 
notes are based on imports of gold, unaccompanied by a 
corresponding increase at the same time of goods already 
in the home markets. 

Underlying all these statements of orthodox economic 
theory is the assumption that there is an exact corre¬ 
spondence, dollar for dollar, between the goods produced 
and the credit created, and the further assumption that 
the new goods and the new credit affect the market at 
the same time. Both assumptions would hold good if 
pecuniary markets did not differ from barter markets: 


218 


MONEY 


neither is warranted with respect to the markets of to¬ 
day. In the United States, the danger of inflation on a 
gold basis is imminent; and there is nothing to prevent 
it in the requirements for so-called self-liquidating paper 
as a basis for bank loans. 

We have observed that the volume of bank deposits 
created in connection with current business does not de¬ 
pend strictly upon the known value of the goods produced, 
but upon somebody’s estimate of future value. Let us 
see what this involves. When anything is used as a me¬ 
dium of exchange, it thereby becomes a measure of value; 
but the use of anything as a measure of value of goods 
that are not exchanged may lead to no end of business 
troubles. If a ton of pig-iron, for example, sells for 
thirty-four dollars, the exchange value of that ton of pig- 
iron at the time of sale is thirty-four dollars. Are we safe 
in assuming that all pig-iron has the same exchange value? 
It would seem so; and the business of the world, for the 
most part, proceeds on that assumption. But we have no 
accurate measure of the value of any commodity except 
at the moment when money is used as a medium for trans¬ 
ferring the ownership of that commodity. The price at 
which one ton of pig-iron is sold is not a measure of the 
exchange value of any other tons of pig-iron. Their value 
can be discovered only in the process of sale. Similarly, 
the fact that 10,000 shares of Studebaker common stock 
sell on a given day at 131 does not indicate the exchange 
value of the other 590,000 shares. Far from it. Nobody 
knows what 100,000 shares would bring, if they were sold 
at market the next day; yet that is the only way to find 
out their exchange value. What we do know with cer¬ 
tainty is that if extraordinary offerings of commodities, 
or common stocks, or pieces of real estate are thrown upon 
the market at one time, there is a sudden fall in prices. 


AS SUSPENDED PURCHASING POWER 219 

Yet, for the daily purposes of business and banking, if 
certain tons, or shares, or acres sell at a given price, we 
are inclined to “value” all other units accordingly. Our 
major economic troubles are due in part to this fact. In 
the domain of commerce and finance, when deciding the 
loan values of securities and especially of commodities as 
a basis for increasing the volume of bank credit, we often 
proceed on the calm assurance that the price at which a 
given unit of anything is actually sold is the price at 
which all other like units would sell. 

/ 

The Three Options that go with Money 

When, in our modern markets, the trader receives 
money instead of corn for his bear-skin, or when the 
manufacturer receives bank credit against watches in the 
course of production, he acquires freedom of choice con¬ 
cerning the time and the place where he will spend the 
money, and concerning the goods he will accept for his 
money. 

The man with money has freedom of choice with re¬ 
spect to the time of spending it. He may withhold it from 
circulation as long as he pleases; at least he may withhold 
that part of his accumulation which he does not need to 
pay taxes and to keep him alive. When the price-level is 
falling, the owner of money has a special reason for hold¬ 
ing it: during the twenty years preceding 1896, everybody 
who refrained from spending money gained because of the 
increase in the purchasing power of money. When the 
price-level is rising, the owner of money has a special 
reason for getting rid of it: in Central Europe, following 
the World War, it was profitable to spend money for 
almost any goods rather than to retain the money, for 
nearly all goods were appreciating in money-value, while 
money was depreciating in goods-value. But apart from 


220 


MONEY 


this special risk of withholding money when prices are 
rising, the risk of withholding money is negligible, since 
money is exchangeable for all commodities and all serv¬ 
ices at all times, and will, therefore, be accepted in un¬ 
limited quantities as long as its acceptance by others is 
not questioned. 

The owner of commodities, on the other hand, has less 
freedom of choice with respect to the time of passing them 
on. The favorite illustration, since Jevons first used it, 
has been the experience of Mademoiselle Zelie, a singer of 
the Theatre Lyrique at Paris, who, in the course of a pro¬ 
fessional tour around the world, was at a loss to know 
what to do with her remuneration for a concert in the 
Society Islands. By contract, she was to receive one 
third of the receipts. 14 When her share was counted, it 
was found to consist of three pigs, twenty-three turkeys, 
forty-four chickens, five thousand cocoanuts, besides con¬ 
siderable quantities of bananas, lemons, and oranges. In 
Paris, as the prima donna remarked, this amount of live 
stock and vegetables might have brought four thousand 
francs, which would have been ample remuneration for 
five songs. In the Society Islands, however, barter pre¬ 
vailed ; and, as Mademoiselle could not herself consume or 
deposit with her Paris bankers any considerable part of 
the receipts, it soon became necessary to feed the pigs 
and poultry with the fruit and vegetables. 

Under a system of barter, purchasing power can be 
withheld only in the form of commodities — sugar, wool, 
eggs, lumber, raspberries, hats, and the like. The possi¬ 
bilities of profitably keeping this kind of purchasing 
power out of the market are rigidly limited, for four 
reasons: (i) Most commodities spoil as money does not; 
(2) as most commodities are bulky, handling, storage, and 
insurance expenses may eat up the profits which might 


AS SUSPENDED PURCHASING POWER 221 


otherwise result from holding the commodities for later 
markets; (3) there are depreciation risks due to changing 
needs, customs, fashions, boycotts, tariffs, weather, and 
means of transportation, which do not trouble the holder 
of money; (4) there is the risk (connected with those 
above-mentioned) that stored-up commodities could not 
be disposed of to advantage at the time when the owner 
might be obliged to dispose of them. 

It is on account of a medium of exchange, therefore, 
that buyers now have a wide range of choice with respect 
to the time of using stored-up purchasing power. This 
is a factor that money has introduced into business, and 
one that must be measured and reckoned with. 

When this time-factor is taken fully into account, 
money, far from obscuring the true nature of modern 
trade, may clarify it as nothing else can. Let us consider, 
for example, what must occur in the markets if any con¬ 
siderable number of traders decide that, for the time be¬ 
ing, they do not care to be parties either to barter trans¬ 
actions or to the exchange of commodities by means of 
money; decide to dispose of all the commodities they 
can sell for money and keep the money; decide, in other 
words, that it is a good time to sell but a poor time to 
buy. In that case, they desire to use money for the time 
being solely as a store of purchasing power, not to use it 
as a medium of exchange. As much money as they receive 
in payment for commodities, and retain for future use, 
is thereby for the time being withdrawn from the volume 
of money used to exchange commodities. As far as cur¬ 
rent trade is concerned, that money might just as well 
have been seized by Captain Kidd and buried in a desert 
island. Thus money has introduced into business trans¬ 
actions a time-factor of far-reaching consequences. In¬ 
deed, as we shall see later on, this time-factor every few 


222 


MONEY 


years has a part in threatening to put an end to all 
transactions, and business is at its wit’s end to find out 
how to get under way again. 

Money always defers the Exchange of Goods 

This is the gist of the matter: money is always a means 
of deferring and sometimes a means of defeating the 
completion of an exchange of goods for goods. The time 
elapsing may be only a minute or two, as when a farmer 
sells eggs at one stall in a market and immediately spends 
the proceeds for beef at the next stall; or the time elaps¬ 
ing may be eternity, as when the money is received for 
goods and then lost or destroyed. Between those two 
extremes are an infinite number of possibilities. In other 
words, money is always a means of deferring repayment 
of goods with goods, which repayment, under a barter 
economy, is never deferred. When we barter a load of hay 
for a harness, we effect an exchange of goods for goods; but 
when we sell the hay for money, we stop there. How long 
do we stop? That apparently innocent question is like 
the bloody questions of Macbeth to Banquo. Upon it may 
hang the tragedy of a business crisis. For when many 
people at the same time decide to stop long, or decide 
suddenly to release the purchasing power they have 
stored up in the form of money, there are changes in the 
relation of supply of goods and demand for goods with 
consequences to business of great importance. 

When men who have withheld money decide to spend 
it, they may offer it in markets which lack a correspond¬ 
ing increase of commodities, since the very fact that the 
money has been withheld may have caused a curtailing of 
production; and it takes time before new commodities 
appear in response to new effective demand. The price- 
level, therefore, may be suddenly changed. On the other 


AS SUSPENDED PURCHASING POWER 223 

hand, there is the extremely important consideration 
that, no matter how large stores of commodities may be 
or how long withheld, they are still stores of commodi¬ 
ties. Whenever the withholder of commodities does 
come into the market, he comes in with commodities. 
A dealer might barter his corn for skins, with the idea of 
holding the skins for speculative gains; but he could 
realize on the transaction only by putting the skins on the 
market. He might thus reduce the exchange value of 
skins, but only by proportionately raising the exchange 
value of other commodities. The importance of this dis¬ 
tinction will appear in connection with any adequate dis¬ 
cussion of business cycles. 

Yet, oddly enough, that distinction has long been over¬ 
looked. It appears that early in the history of human 
relations, men became so accustomed to taking money 
for goods and keeping the money as long as they pleased, 
that they failed to perceive the importance of the time- 
factor; just as they saw untold millions of nuts fall to the 
ground before any one induced from so common an ex¬ 
perience the law of gravitation. It is the neglect of this 
time-factor that makes the classical argument unsound. 
When we simplify our thinking in the approved way, in 
order to see beneath what writers have long called “the 
money surface of things,” we think of commerce only as 
the exchange of present goods against present goods. But 
that is barter, pure and simple. The moment money is 
thrust in between the two commodity-ends of the trans¬ 
action, we must think of commerce as it always is, 
namely, either the exchange of goods for money and the 
subsequent exchange of that money by somebody for 
goods, or the exchange of goods for money followed by the 
extinguishing of the money. Is the exchange of goods 
ever completed? If so, how much time elapses between 


224 


MONEY 


the two transactions? Those crucial questions we over¬ 
look whenever, following traditional economic precept, 
we attempt to explain current commerce by reverting to 
the simple barter trade which, within the United States at 
least, has been all but abandoned. 

The Goods Option that goes with Money 

The owner of money has freedom not only with respect 
to time, but also with respect to the goods he will buy. 
The owner of wheat may sell wherever there is a buyer of 
wheat, and the buyer may buy wherever there is a seller 
of wheat. In this respect, the buyer of wheat and the 
seller of wheat have ranges of choice which would be bal¬ 
anced in the long run, were it not for the further fact that 
the buyer, by virtue of holding money, has the additional 
choice of not buying wheat at all, but buying a substitute; 
whereas the seller must sell wheat to somebody, some¬ 
time. The holder of diamonds, phonographs, furs, or 
other commodities which the buyer may classify as non- 
essentials, is at a further disadvantage, since the holder 
of money need not even seek a substitute. He may re¬ 
frain from buying non-essentials of any kind. In 1920 
and 1921, the disadvantages of holders of goods became 
painfully obvious to everybody who had stocks on hand 
of piano-players, ornaments, or even such essentials as 
leather, copper, wool, and cotton. 

The holder of money has choices among many goods. 
He may use his money to buy a coat of the latest style 
(new consumers’ goods); or he may order a tractor (new 
capital goods); or he may invest in rare books (old con¬ 
sumers’ goods); or, finally, he may buy a factory (old cap¬ 
ital goods). Under a barter economy, on the other hand, 
with its inefficiency and waste, there could not be the 
large investments we have to-day; nor could there be the 


AS SUSPENDED PURCHASING POWER 225 

sudden changes in the relative amounts invested in these 
four classes of goods, for there could be neither the vast 
stock of goods nor the vast stock of mobile purchasing 
power that has resulted from the efficient, large-scale pro¬ 
duction of a money economy. 

The Place Option that goes with Money 

This freedom of choice with respect to the kind of goods 
the holder of money may buy is enlarged by the greater 
geographical range of his markets: he is not confined to 
the choice available in the place where he wishes to dis¬ 
pose of his goods and in the places to which he can trans¬ 
port them with the hope of trading. Without leaving his 
ranch at Sheridan, Wyoming, he may sell his cattle and 
exchange the proceeds for a box of oranges in Florida, an 
automobile in Detroit, and a thousand other commod¬ 
ities that a mail order house in Chicago will collect for 
him from distant producers who never heard of him, or 
of his cattle, or of Sheridan, Wyoming. He may spend 
his money locally, nationally or internationally, by mail, 
telegraph, or cable, wherever a system of money exchange 
is in working order. This geographical range of choice 
of the holder of money is of fundamental importance. 

Under a barter economy, on the other hand, the owner 
of goods would find his markets restricted geographically. 
The barter trader could not suddenly affect his local 
markets by offering his goods in foreign markets. For 
many months following the World War, for example, the 
surplus wheat in Southern Russia could not find its way 
to outside markets, or even to other parts of Russia, be¬ 
cause the Russian monetary system had broken down 
and barter was the only means of exchange. Though 
barter traders could carry goods to distant ports, as New 
England sea captains did a century ago, and take their 


226 


MONEY 


chances in each port, the time involved would be so great, 
and the volume of goods thus risked would be so small, 
that the disturbance in prices and production caused by 
such cumbersome trade would be comparatively slight. 
Under a barter economy, a dealer could not ship skins 
from Chicago to Bordeaux and, before the skins had left 
the freight yards, obtain payment in gloves at Chicago. 
Yet this is typical of the transactions that money and 
bank credit have made everyday occurrences. 

Indeed, it is of the utmost consequences to the whole 
economic order, as we shall see in some detail later on, 
in what directions the holders of money exercise this 
freedom of choice at any one time; for a marked change 
in the relative amounts of purchasing power devoted to 
the four classes of goods enumerated above, or a marked 
change in the relative amounts devoted to commodi¬ 
ties and to services, causes changes in prices, in wages, 
in profits, and in volume of production, often with 
the familiar train of consequences suffered in periods 
of depression. 

We may note, finally, that the change from a barter 
economy to a simple money economy, thousands of years 
ago, did not at once inflict upon society the problems 
that, from the beginning, were inherent in th'e use of a 
medium of exchange. It was natural that for many cen¬ 
turies men should think only of the conveniences of 
money. Not until the development, during the past 
century, of a highly complicated industrial and financial 
organization, was it possible for the use of money as sus¬ 
pended purchasing power to have a part in causing eco¬ 
nomic disturbances on a large scale. 

Summary 

Because of these three choices, as to time and goods and 


AS SUSPENDED PURCHASING POWER 227 

place , which go with money, the individual as a buyer is 
almost always in a strategic position. The individual as a 
seller ordinarily is not, for he has but one choice — 
namely, to sell for whatever price the buyer decides to 
pay for his goods, or keep the goods. There are alterna¬ 
tions, to be sure, between what we call “buyers’ markets” 
and “sellers’ markets.” During the World War, the man 
who had hides to sell was in a fortunate position, for 
people were prepared to buy, at current prices, more 
hides than there were in existence. It was a “sellers’ 
market.” In April, 1921, it seemed as though nobody 
wanted to buy hides at any price. Certain grades were 
eighty-one per cent below the highest price of 1919. It 
was a “buyers’ market.” There are fluctuations of this 
sort that affect the degree of the advantage of the buyer 
over the seller; but in all markets the advantage persists 
— and it persists by virtue of the three choices that go 
with the buyer’s money. The owner of money, therefore, 
as the holder of such a convenient store of suspended pur¬ 
chasing power, virtually controls the production sched¬ 
ules of the world; and, in the very process of exercising 
this control — the spending of his money — he deter¬ 
mines for the most part the prices at which goods are 
sold. For this reason, studies of the ups and downs of 
business may well begin with changes in the volume and 
distribution of purchasing power relative to changes in 
available goods. To that subject we shall now turn. 


/ 


f 


J 


CHAPTER XIII 

MONEY IN RELATION TO GOODS 

The perfect balance between the supply of goods and 
the demand for goods that prevails in barter markets 
may be upset, as we have just observed, by the introduc¬ 
tion of a medium of exchange. The fact that money is 
suspended purchasing power — that it always defers the 
exchange of goods for goods — is alone sufficient at any 
time to bring about some disturbance of the balance of 
supply and demand, regardless of changes in the quan¬ 
tity of money in circulation. 

Money introduces a further possibility of market dis¬ 
turbance; for money, unlike any of the goods that are 
used in barter exchange, can be increased suddenly and 
at the will of governments, and without any reference 
whatever to changes in the supply side of the equation. 
Every country that has adopted any form of money has 
experienced, sooner or later, an increase in the volume of 
money which has had no necessary relation to changes in 
the quantity of goods on hand, or to movements of the 
price-level, or to the rate of increase of production of 
goods, or to the time of the appearance of the goods on the 
markets, or to changes in the relative amounts of money 
used for the purchase of finished goods and for other 
purposes. In short, the volume of money often changes 
without reference to changes in the volume of the work 
to be performed by money: demand changes regardless 
of supply. 

Production of Money surpasses Production of Goods 

Such an experience has recently thrown the markets 


MONEY IN RELATION TO GOODS 

of the United States into confusion. For many years; 
according to the independent studies of Messrs. Day, 
King, Snyder, and Stewart, the increase in the physical 
volume of production in the United States averaged 
not far from 4 per cent per annum. 1 During the War, the 
rate increased. In 1918, the volume of production was 
estimated as 25 per cent greater than in 1914. In 1919, 
however, there was a slump: production fell off until the 
volume was not more than 14 per cent in excess of the 
volume for 1914. During these years, the increases in 
money and bank credit were far greater. More than a 
billion dollars in gold came from Europe; and the Federal 
Reserve System allowed this gold to serve as a basis for 
more than twice as much bank credit as would have been 
allowed under the old national banking system. It seems 
that the new system enabled every gold dollar to support 
at least seven dollars of bank credit. 2 From June, 1914, 
to June, 1919, the increase in the estimated volume of 
money, outside the Treasury and the banks, was nearly 
120 percent. From January 1, 1915, to January 1, 1920, 
according to the data compiled by the Federal Reserve 
Bank of New York, the currency in circulation, outside 
the Treasury and the Federal Reserve Banks, increased 
about 62 per cent and deposits in National Banks in¬ 
creased about 119 per cent. How commodity prices 
soared during this period of money expansion, while the 
rate of increased production varied but little, is shown in 
Figure 11. 3 One of our bank economists says that “in the 
latter part of 1919 and the early part of 1920, we were 
carrying full sail and throwing out all possible additional 
canvas, driving ahead under what seemed to be favor¬ 
able winds, and largely oblivious that a hurricane was 
impending.” Evidently we were counting on inflation of 
the currency to fill out the sails and keep the ship going, 



I 


I 


MONEY 


but we were producing smaller cargoes than in 1918. 
From all these facts, it is evident that there was a wide 
discrepancy between the production of goods and the 
production of money. 


PRICES IN RELATION TO PRODUCTION 



It is not easy to discover precisely how, and under 
what circumstances, and to what extent money upsets 
the balance of supply of goods and demand for goods. It 
is easy to see that if the United States Government had 
suddenly thrown upon the markets all the wool it had ac¬ 
cumulated during the War, it would thereby suddenly 
have changed the relation of supply and demand, to the 
consternation of wool growers and the temporary confu¬ 
sion of markets. It is as readily understood that if the 
Government could to-morrow miraculously double the 
number of automobiles in the hands of dealers, it could 
thus upset the existing balance of supply and demand. 





























MONEY IN RELATION TO GOODS 


1 

t 

231 

It is more difficult to comprehend the unbalancing that , 
comes from changes in the demand side of the ratio, j 
Ordinarily, no government can suddenly double the sup¬ 
ply of wool or automobiles or any other commodity; but 
any government can easily double the money in circula¬ 
tion and thus create a demand, at prevailing prices, for 
more goods than there are in the whole country. Ever 
since the invention of the printing press it has been easy 
to make sudden increases in the volume of paper money 
that passes from hand to hand. 

Inflation by Means of Bank Credit 

It is easier still, in the United States, to bring about in¬ 
flation by means of bank credit. When the banks in New 
York, on September 15, 1920, loaned the United States 
Government $200,000,000 by writing that amount in 
their books, the total bank deposits of the country were 
increased by that amount, except in so far as any part 
of it was used to cancel old obligations. The result was 
increased dollar-demand for goods but no increase of 
goods. The amount spent by the Government went pres¬ 
ently into other banks and thence to other uses; and it 
had the same effect as printed money. If the Govern¬ 
ment had inflated the currency, as it did following the 
Civil War, by printing money in the form of greenbacks, 
and had paid them out directly for war materials, many 
people would have seen at once that the quickest way to 
restore the old relation of supply of goods to demand ex¬ 
pressed in dollars would be to take this excess of paper 
money permanently out of circulation. When, however, 
money is inflated by the simple, and to most people ob¬ 
scure, method of writing credits on the books of banks, 
not one person in a hundred knows what has happened. 
And some of those who go so far as to observe the growth 


232 


MONEY 


in the volume of bank deposits regard this growth as 
evidence of national prosperity. 

The creation and extinction of bank credit is constantly 
changing the relation between the number of dollars 
offered in the markets at a given time and the amount 
of goods available for the dollars at that time. These 
changes come about in various ways, and they occur 
whether or not the Government at the same time makes 
any changes in the character or volume of currency. If, 
for example, any holder of goods offers the goods as 
security for a loan and is given bank credit, new purchas¬ 
ing power is created without necessarily placing new 
goods on the market. In fact, the borrower may seek the 
loan for the purpose of temporarily keeping goods off the 
market. Many loans made in 1921 to holders of farm 
products, leather, copper and cotton were made to en¬ 
able the owners to retain their goods for higher prices. 
Purchases made with the proceeds of such loans did not 
“mean prior sales”; quite the contrary. To the extent 
of such loans, therefore, the balance between the volume 
of goods on the market and the volume of purchasing 
power was disturbed — an impossibility jn a barter 
market. No such disturbance occurs when the borrower 
finances his enterprise by the sale of bonds which are 
purchased out of savings, or by placing a mortgage with a 
savings bank; for, in such cases, the money is merely di¬ 
verted from certain uses to other uses, while the total 
volume remains unchanged. But new commercial bank 
loans, even when based on a small proportion of the 
nation’s total wealth, may mean large increases in the 
volume of circulating purchasing power, and, therefore, 
may mean large changes in the ratio of supply and de¬ 
mand; for, if the total wealth of the United States is 
$300,000,000,000, while the total money in circulation 


MONEY IN RELATION TO GOODS 


233 


is $30,000,000,000, new loans equal to one per cent of 
the wealth would mean a ten per cent increase in money. 

Even greater than this are the possibilities of inflation, 
for most bank loans are not secured by mortgages, that 
is to say, by a physical volume of goods. The goods 
themselves, usually, are not pledged by the borrower, un¬ 
less — as in the case of the Goodyear Tire and Rubber 
Company in 1921 — the credit of the borrower is ques¬ 
tioned. Ordinarily, credit is extended by the banks on 
the general reputation of the borrower. It is commonly 
said, “That man is good for any amount of credit he asks 
for, because he will not ask for larger loans than he can 
repay.” In 1920, national bank loans, unsecured by 
collateral, reached a total in excess of seven billion dollars. 
Thus, reputation or the mere possession of wealth, when 
bank credit is expansible, sometimes enables a man to 
increase his purchasing power, and to use it in various 
directions, without giving up any of his property or even 
specifically pledging any part of it. 

Bank credit is also created in vast amounts merely on 
the expectation that goods will be produced. Indeed, this 
is the chief use of bank credit: it enables manufacturers 
to pay for labor and materials before there are any fin¬ 
ished goods to pledge as security. The goods may never 
be produced or may be unsalable when produced, but the 
credit goes on circulating as a part of the increased cur¬ 
rency of the country, until the loan is paid in some way 
and the amount of credit in question is thereby cleaned 
off the books of the bank. It is true that if the borrower 
does not succeed, according to expectation, in paying 
his debts at the bank with the proceeds of the sale of his 
goods, eventually he must produce and sell other goods, 
or in some way obtain the necessary funds. But, mean¬ 
time, the balance between money and goods has been 



234 


MONEY 


disturbed precisely to the extent of the money that was 
borrowed and placed in circulation. Time is the essence 
of the problem, and time is one of the factors in the ex¬ 
change of goods for goods which we must charge to the 
account of money. 

Rarely is increased bank credit that is used for con¬ 
sumers’ goods exactly offset by increased production of 
consumers’ goods at the current price-level. Even in those 
rare cases, the ratio of money and goods is ultimately 
disturbed unless production continues at the higher rate; 
or the new money is withdrawn from circulation; for 
the original volume of goods is consumed, while the 
credit may continue to circulate as a demand for more 
goods. 

Inflation due to Government Financing after the War 

This ability to create credits, through the issue of Gov¬ 
ernment obligations in exchange with the banks for cur¬ 
rent purchasing power, enabled the United States Gov¬ 
ernment to disturb the balance of supply of goods and 
demand expressed in dollars by increasing its expendi¬ 
tures on a scale that might otherwise have been impos¬ 
sible. Fully a year and a half after the armistice, the 
Government was spending money at the rate of about 
seven billion dollars a year. In 1921, the Government was 
still spending four or five times as much as it spent before 
the War. The continuation of vast expenditures on the 
navy and on the building of ships continued to keep labor 
and materials away from other fields. Had the Gov¬ 
ernment been obliged to obtain all the funds for these 
expenditures directly from the savings of the people, in¬ 
stead of partly through inflation of bank credit, the re¬ 
lation of supply to demand expressed in dollars would not 
have been disturbed by Government financing; for the 


MONEY IN RELATION TO GOODS 


235 


increase in effective Government demand might have 
been offset by the decrease in effective taxpayers’ de¬ 
mand. 

Our railroad difficulties following the War were also 
due in part to expansion of bank credit for Government 
uses. Economic maladjustments occur wherever there is 
interference with supply and demand, as there is when¬ 
ever there are sudden changes in the relations of costs 
and prices to each other. When these maladjustments 
occur in an industry such as transportation, which affects 
all others, the whole economic process of production, dis¬ 
tribution, and consumption gets out of equilibrium. This 
was what happened when the Government took charge 
of the railroads and maintained rates that did not pay 
the cost of operation. On account of this policy, the 
railroads were called upon to handle more passengers and 
goods, at the established rates, than they would have 
been called upon to handle at rates which paid operating 
expenses. Thus, the difficulties of traffic were aggravated. 
It is not likely that the Government would have paid the 
deficits, and thus maintained this economically unsound 
condition, without the inflation of bank credit; for it is 
not likely that the Government would have asked all the 
people to pay direct taxes in order to maintain railroad 
wages at a level which seemed to most of the voters in¬ 
ordinately high. Thus the railroad troubles of 1921 and 
1922 were in no small measure due to the inflated bank 
credit of previous years. 

Inflation a Cause of Unbalanced Foreign Trade 

It was credit extended, directly or indirectly, to Eu¬ 
ropean countries, by banks in the United States, that 
made possible the unbalanced foreign trade in the years 
following the armistice when, with the greater part of the 


MONEY 


236 

world indebted to us, we were still exporting more goods 
than we were importing. Even in the latter part of 1920 
there was an increase in the trade balance, with a con¬ 
sequent increase at home in the difficulties of “returning 
to normal” or “restoring our economic equilibrium.” 
Under a barter economy our exports, so far as there were 
any, would have been paid for in goods. There could not 
have been the long-continued abnormality of a creditor 
country having a vast export balance, without a vast in¬ 
crease of tangible goods owned abroad. 

During 1919 and 1920, at the same time that we were 
sending out of the country far more goods than we were 
bringing in, we were exporting gold. During those two 
years our exports of gold were nearly half a billion dollars 
in excess of our imports of gold. According to the tradi¬ 
tional view, it was impossible for a creditor country to 
continue, year after year, to have exports far in excess 
of imports without, at the same time, gaining gold or 
increasing its ownership of capital goods abroad. It was 
only the extension of bank credit to Europe, in unprece¬ 
dented totals, that made this condition possible. As Eu¬ 
rope had insufficient goods with which to pay her bills, 
and as other countries did not take over Europe’s debt 
to us, we could not use our credits with Europe to pay 
our debts to the rest of the world. We were obliged, there¬ 
fore, to pay with gold for our imports from non-European 
countries in excess of our exports to those countries. Such 
unbalanced trade relations could not have persisted with¬ 
out expansible bank credit. 

During the years 1919 and 1920, on account of our 
extension of credits to Europe, we lost commodities, but 
continued to increase our bank credit. This further dis¬ 
turbed the relation of volume of money at home to vol¬ 
ume of commodities at home, and thus stood in the way of 


MONEY IN RELATION TO GOODS 


237 


restoring lower prices and economic equilibrium at home. 
If this appears too obvious to be worth mentioning, it 
may be added that it was in the midst of these economic 
difficulties and high prices, due in no small measure to 
credits already extended to Europe, that Congress passed 
resolutions for the avowed purpose of extending more 
credits of the same sort to Europe in order to reduce the 
high cost of living at home. Speaking in favor of reviving 
the War Finance Corporation, several members of Con¬ 
gress said, in substance, that we ought to extend credits 
freely to foreign countries in order to enable them to buy 
from us, at prevailing prices, products in some of which 
they could undersell us in our own markets. At the same 
time a majority of the members of Congress appeared to 
favor tariffs that would prevent foreign countries from 
repaying these loans with any of their products, although 
this was the only large means that the greater part of 
Europe had of sending payments to this country. That 
suggests the dilemma of the reparations: all the Allied 
nations were agreed that Germany could pay the in¬ 
demnities only with goods; all the Allied nations were 
agreed that they did not want German goods. The 
United States can furnish abundant proof, out of its own 
costly experience, that a combined protective tariff and 
credit-extension policy, which sends commodities abroad 
and shuts out foreign commodities, cannot reduce the 
cost of living at home. It has exactly the opposite effect. 

Demand for Goods not satisfied by Expansion of Bank Credit 

At the close of the War, since commodities were scarce, 
dealers were asking for bank credit with which to buy 
supplies to meet what appeared to be increased demands. 
There was no doubt about the need for commodities. The 
supply was deficient because the War had destroyed 


MONEY 


238 

commodities and at the same time interfered with peace¬ 
time industries. The call for increased bank credit came 
in part from men engaged in what is ordinarily called 
“necessary business.” They regarded themselves as en¬ 
titled to bank credit, as they wanted it for the purpose of 
satisfying what we had come to regard as “legitimate” 
needs. The trouble was that, in the extraordinary condi¬ 
tion of the markets immediately following the War, it was 
not possible at once to supply even what had come to be 
regarded as an ordinary demand. Whenever such a con¬ 
dition exists, as it did in virtually all the world following. 
the War, the desire for bank credit cannot be satisfied 
by creating new bank credit. The demand is insatiable. 
It defeats itself by lifting the price-level. “ Cheaper 
money” is not a remedy; it is a dangerous stimulant. It 
makes the malady worse and the recovery more difficult. 
The only way to satisfy the demand for more commodi¬ 
ties, at the old price-level, is to produce commodities in 
proportion to the increased money, until the former bal¬ 
ance of supply of commodities and demand in dollars is 
restored. The increase in bank credit might be rendered 
harmless if there were a corresponding increase in idle 
cash balances — idle from the standpoint of the whole 
community. But when prices are rising, bank balances 
are least likely to lie idle. In other words, newly created 
bank credit goes into circulation most promptly precisely 
when the total volume is expanding most rapidly. For, 
at such times, it is profitable to turn it quickly into 
commodities which are appreciating in value, while the 
money itself is depreciating in value. 

All these maladjustments of demand and supply are 
monetary phenomena. Under a barter economy, such 
discrepancies between changes in supply and changes 
in demand would be impossible: there could be neither 



MONEY IN RELATION TO GOODS 


239 


“inflation of the currency” nor a “dearth of currency,” 
since there would be no currency. In other words, the 
total volume of marketable goods offered for sale and 
the total volume of purchasing power — the supply and 
the demand — would be one and the same thing. 

Fallacies concerning Relation of Money and Goods 

Before we pass over this attribute of a money economy, 
as too obvious to be worth mentioning, we should note 
that economists as well as governments have failed fre¬ 
quently to take it into account. Even some of the world’s 
most noted economists appear to have overlooked the 
fact that the perfect barter balancing of supply and de¬ 
mand is upset, under all monetary systems, by changes 
in the volume of money that have no necessary relation 
to changes in the volume of goods. What this traditional 
failure leads to is shown by such statements as the follow¬ 
ing from the distinguished French economist, Charles 
Gide: “In our everyday life we are too apt to imagine 
that sale and purchase are independent and self-sufficient 
processes. That is a mistake. Every purchase means a 
prior sale; for before being able to exchange money for 
goods we must previously have exchanged goods for 
money. Inversely, every sale points to a future pur¬ 
chase.” 4 This is doubly false: not every purchase means a 
prior sale, and not every sale points to a future purchase: 
for, as we have just observed, purchases may be made 
with paper money just created by act of Congress; and 
money received from the sale of commodities may be re¬ 
tired from circulation by act of Congress. Or, as in the 
cases cited above, purchasing power may be obtained, not 
from sales, but from the expansion of bank credit; and 
money obtained from sales may be used, not for the pur¬ 
chase of commodities, but for the repayment of bank 


240 


MONEY 


loans and the consequent reduction of the volume of 
bank credit. It is only in barter trading that sale and 
purchase cannot be independent and self-sufficient proc¬ 
esses. 

Yet this doubly false explanation of money, in its rela¬ 
tion to sales and purchases, continues to appear in the 
most reputable of treatises as if it were a fundamental 
characteristic of all monetary transactions of modern 
times. In The Functions of Money , published in London 
in 1921, William F. Spalding says: “It is true, as the 
French economist, Professor Gide remarks, that each 
purchase must have necessitated a previous sale, that is, 
when exchanging commodities for the money substance, 
since prior to exchanging money for goods, there must 
have been first an exchange of goods for money. On the 
other hand, every sale presupposes a purchase for the 
future, for the very simple reason that if we exchange 
commodities for money we do so in the belief that later 
on we shall be able to exchange this thing called ‘ money ’ 
for other commodities. Nevertheless, ip every case the 
two operations form a complete entity.” 5 Here we have 
the old explanation offered again in its pristine simplicity, 
as if the world had not yet learned how to use bank credit 
or even the printing-press. Most emphatically the two 
operations do not form a complete entity. 

These quotations are typical of the fallacies which 
some men fall into because of their unthinking repetition 
of statements that were first made of a radically different 
monetary world, because of their habit of applying to our 
own day conclusions drawn from days of barter trading, 
and because of their assumption that the use of money is 
only a superficial phenomenon. Perhaps no error is more 
likely to obscure the most serious of our current economic 
problems. Indeed, if this traditional explanation of mon- 


MONEY IN RELATION TO GOODS 


241 


etary transactions were sound, no explanation whatever 
would be possible of the rise in prices from 1914 to 1920. 
It simply could not have happened, for there would not 
have been enough dollar-demand to carry the prices so 
high. To assert that every purchase means a prior sale 
and that every sale points to a future purchase, is to • 
divert attention from one of the most profitable of all 
fields of study concerning commercial “booms” and 

i i • j 9 

panics. 


CHAPTER XIV 

MONEY AND SPECULATION 

. It is no part of our purpose to discuss here the various 
good and ill effects of speculative dealings in general 
which are discussed at length in the textbooks. 1 We shall 
go no further into this extensive subject than to note 
some of the ways in which fluctuations in the volume of 
money and in the price-level accentuate the evils, with¬ 
out increasing the benefits, of speculation. In all that we 
say, therefore, we are concerned, not with those specula¬ 
tive aspects of trade which are inherent in all transac¬ 
tions, even on a stable price-level, but with those activi¬ 
ties in commodity markets which are due primarily to 
changing price-levels. 

In a period of rising prices, the growth of speculation, 
particularly in the United States, is facilitated by expan¬ 
sible bank credit. Without its aid, extensive speculation 
in a wide range of commodities would be impossible. 
When speculative buying slows down, it is accompanied 
by the complaint of speculators that the banks will not let 
them have “any money to do business with.” The spec¬ 
ulative buying which took place in this country during 
1919 could not have occurred under a barter economy; nor 
could it have occurred under a monetary system which 
permitted increases of money and bank credit only in pro¬ 
portion to the rate of increase in production or in volume 
of trade. The unprecedented increase in bank loans 
(shown in Figure 12) 2 enabled many speculative middle¬ 
men, of no economic advantage to the community, to 
thrust themselves into the processes of distribution and 
retard the flow of goods. 


MONEY AND SPECULATION 


243 


The rapid rise in prices, which, as we have seen, was 
possible in this country only with inflation of the cur¬ 
rency, was an incentive to speculation in commodities. 
Rising prices, as we have just observed, made ‘‘profit- 



1919 1920 1921 


Figure 12. Loans of all Reporting Banks compared with Street 

Loans, 19 i 9-192 i 

eers”: the “profiteers” did not initiate the rise in prices. 
The speculation itself involved demands for credit expan¬ 
sion. So far as the new credit was used outside of specu¬ 
lative channels, it tended still further to increase prices 
by adding to the dollars available for goods. So far as this 








































244 


MONEY 


new credit was used to withhold goods from the market, 
it tended to increase prices by decreasing the volume of 
goods available for the dollars. Higher prices became in¬ 
centives to further speculation, and so on up the ascend¬ 
ing spiral. t 

The dangerous level to which prices were thus driven 
was evident to everybody in the case of sugar — after 
the crash came. American speculators bought sugar not 
only in Egypt and Sweden and Bolivia, but even in 
Kwantung, Czecho-Slovakia, and thirty-five other coun¬ 
tries. In the scramble of speculators, including many men 
who had never dealt in sugar, to make money on a rising 
market, the ordinary consumers’ demand for sugar was 
ignored. As a result, the markets of the world were 
thrown out of balance. Sugar, which had been shipped 
from the United States to England at a price, was brought 
back to be sold at home at a higher price. The apparent 
shortage of sugar in the United States was due in part to 
the withholding of sugar from the market, as became 
clear when the break in prices revealed the surplus supply 
on hand and on the way from other countries. In 1921, 
after the market price of sugar had dropped to five and 
one-half cents, men were paying twenty-four cents a 
pound for sugar ordered the previous year. In July, 1920, 
the price of sugar in the United States was the highest in 
the world: six months later it was the lowest in the world 
(except in Germany and Czecho-Slovakia, where the 
price was arbitrarily fixed by the Government). This sin¬ 
gle instance shows how the distribution of a staple com¬ 
modity can be interfered with throughout the world, to 
the loss of everybody except a few of the speculators, 
when the bank credit of a single country is sufficiently 
elastic to provide speculators with “plenty of money to do 
business with.” 


MONEY AND SPECULATION 


245 


Although speculation has taken place under a barter 
economy, it has been, necessarily, on a small scale, and 
never in many commodities at one time, partly because 
of the slow, cumbersome, and risky nature of barter trans¬ 
actions, but more particularly because the chief incentive 
to widespread speculation — namely, a large and sudden 
increase in the general price-level — is lacking under a 
system of exchange which involves no such thing as a 
price-level. The business cycle, therefore, in so far as it is 
complicated by speculation financed by bank credit, is a 
monetary problem. And speculation is a factor in every 
commercial crisis because, under our present monetary 
system, speculation boosts prices and heaps up debts, 
based on an inflated currency, which, sooner or later, 
debtors cannot pay. Whether speculation will continue 
to be a major cause of business crises appears to depend on 
our ability to find out much more about the exact work¬ 
ings of the monetary factors and to make use of this 
knowledge. 

Competition among regular buyers to get goods for 
immediate use or sale — quite apart from speculative 
buying — is a factor in the upward price-movement. As 
soon as the opinion spreads among buyers that prices are 
going up, they rush into the market and exercise their 
power of upsetting the balance of supply and demand, 
which power they enjoy by virtue of the characteristics of 
money. 3 Buying is a mass movement. At one moment, 
nobody wants to buy since everybody expects prices to 
go down; the next moment, everybody wants to buy 
since everybody expects prices to go up. That is why 
there is no continuous market for pig-iron, or rubber, or 
leather, or for any other commodity the buyers of which 
can stay out of the market for months at a time, but must 
buy eventually. Price has little to do with the attitude of 


246 


MONEY 


such buyers, except in so far as it leads them to expect a 
change in price, or a period of stable price, and cost of 
production has little to do, on any given day, with price 
or with the attitude of buyers, except in so far as the de¬ 
viation of price from cost of production leads buyers to 
expect a change in price. No price is too high to be tempt¬ 
ing, if a higher price is expected; no price is low enough to 
be tempting, if a lower price is expected. That is why 
price-reductions, instead of stimulating sales, often have 
exactly the opposite effect. The man who is about to pur¬ 
chase an automobile for one thousand dollars is likely to 
buy quickly if he finds the price has gone up fifty dollars. 
If, however, he finds that the price has gone down fifty 
dollars, he may hold off in the hope of further reductions. 
This helps to explain the slump in the entire automobile 
market, in the fall of 1920, following the reduction in the 
price of Ford cars. 

Once the buying movement has started, everything 
helps it along. When everybody is buying, everybody is 
optimistic; it is more difficult to get orders filled and more 
difficult to get goods transported. Therefore, everybody 
is inclined to place larger orders, and to place them far¬ 
ther than usual ahead of their needs. Thus, any competi¬ 
tion at all among buyers, which begins with the mere ex¬ 
pectation of higher prices, tends, when sustained by an 
increased volume of bank credit, to make prices actually 
higher, competition keener, and speculators more eager 
to buy. 

In this stage of the business cycle, when the rapid in¬ 
crease of circulating purchasing power is facilitating spec¬ 
ulation and carrying business forward to certain trouble, 
the monetary system of the United States shows great 
elasticity. The higher the price, the more eager are the 
borrowers to obtain loans, the higher are the dollar-values 


MONEY AND SPECULATION 


247 


of the goods offered as security for loans, and the larger, 
therefore, are the loans which the banks feel safe in mak¬ 
ing. It is not in the interests of any one bank to try to 
stem the tide, since refusal to take care of a customer who 
offers what passes as adequate security might only send 
the customer to a bank across the street. Thus all influ¬ 
ences work together to expand credit precisely when ex¬ 
pansion is most dangerous for business as a whole. 4 

It is a fundamental defect of bank credit, on the other 
hand, that the amount needed as circulating purchasing 
power, to keep men employed and the wheels of industry 
moving, goes out of existence precisely when it is most 
needed. Holders of large stocks due to forward buying, 
rather than to pure speculation, know from experience 
that a period of great activity has always led to a period 
of depression. As soon as they see a storm brewing, some 
of them throw goods overboard in an effort to avoid being 
shipwrecked. Holders of speculative stocks, as a rule, 
have no choice. Since they have used the proceeds of 
bank loans to purchase their stocks, they are forced to 
market them under pressure from the banks. The banks 
have little choice: they also must protect themselves. 
The change of facts itself forces them to act: the security 
upon which the loans were originally made is there in 
goods, but not in value. 

The resultant drop in prices, particularly in raw ma¬ 
terials, is precipitous. As nobody knows when the move¬ 
ment will come to an end, nobody orders more goods than 
are absolutely necessary. The general expectation that 
prices will go lower puts a brake upon the forward move¬ 
ment of business. New orders are placed merely to cover 
day-to-day needs; many old orders are cancelled, and 
some goods which have been delivered are returned. As a 
result, nearly all manufacturers either reduce their scale 


248 


MONEY 


of operations or close down completely. To meet re¬ 
duced pay-rolls and reduced purchases, less money is 
needed. As rapidly as possible, therefore, they pay their 
bank loans. Their banking operations are offset to some 
extent by dealers who are increasing their bank loans be¬ 
cause collections are slow. The net result, however, is a 
decrease in the circulating purchasing power of the 
country. This decrease, whatever the initial cause may 
be, tends further to reduce both prices and volume of 
orders; which, in turn, tends still further to decrease 
employment and the volume of money in consumers’ 
hands, precisely when an increase in both is most 
needed. 

Thus a period of prosperity comes to a close largely be¬ 
cause industry is not financed in such a way as to place 
enough money in the hands of consumers to take away, 
at current prices, all that the markets offer. When this 
deficiency occurs, the only way in which bank credit can 
supply the lack of circulating purchasing power is through 
loans made by somebody; but at such a time nobody cares 
to risk losing his whole business through incurring new 
debts for the purpose of making goods that may have to 
be sold at a loss. The banks are powerless: bank credit 
is not created without borrowers. 5 The individual could 
help the general situation by using the proceeds of a loan 
to hire unemployed men, thus immediately putting more 
money into circulation; but most of it would be used to 
purchase other men’s products. At such times, bank 
borrowing that is good for business as a whole is good for 
the individual only if others also borrow; but in a business 
depression our money economy does not induce prompt 
group action. This is the dilemma: most producers do not 
feel safe in using bank credit to resume or extend their 
business until there is a considerable increase of con- 


MONEY AND SPECULATION 


249 


sinners’ purchasing power in daily use; but there is no 
considerable increase until producers use bank credit. 

The great merit of the elastic feature of our Federal 
Reserve System is said to be that it responds quickly to 
the needs of business. As a matter of fact, when prices are 
rising it responds too readily to the pressure of business 
for loans, relying on the theory (which we have shown to 
be fallacious) that the so-called self-liquidating loans can¬ 
not cause inflation. Thus, the Reserve System gets into a 
position in which it cannot take care of the resultant un¬ 
toward business situation. In other words, bank credit 
expands most readily when, for business as a whole, ex¬ 
pansion is most injurious; and it contracts most readily 
when, for business as a whole, expansion is most benefi¬ 
cial. These evils were not introduced by the Federal 
Reserve System: they existed under the old banking 
system. Indeed, the shortcomings of the old system, 
the panics which it was powerless to avert, and the 
superior features of the present system are well known. 8 
Our purpose is not to contrast the Federal Reserve 
System unfavorably with any of the systems of the past, 
but to call attention to some of the monetary problems 
that are yet to be solved. 


CHAPTER XV 
MONEY IN PRODUCTION 

Money has been an indispensable means by which man 
has developed the specialization and cooperation which- 
characterize modern industry, accumulated a vast store 
of wealth, created modern nations, and made possible 
our present standards of living. Without money, it would 
be impossible to maintain either the production or the dis¬ 
tribution that determine the real wages of modern times. 
This is the general conclusion we reached at the close of 
our account of the more obvious uses of money as a me¬ 
dium of exchange. We may well consider the further 
significance of the fact that money is indispensable to 
production. 

Before we proceed, however, we should emphasize the 
fact that our discussion is concerned with money in an in¬ 
dustrial order that is based on the private ownership and 
operation of the agencies of production, conducted for 
profit, under the freest possible conditions of competition 
and individual initiative. Naturally, those who believe in 
a radically different industrial order will disagree radi¬ 
cally with what we say concerning the function of money 
in production. We would gladly discuss what might 
happen in a far different world, if we could find any¬ 
where a clear description of that world. In the pres¬ 
ent volume, we are concerned only with the role of 
money in the world in which we live — a world that 
preserves the fundamental characteristics, which we 
have just enumerated, of the present economic order in 
the United States. 


MONEY IN PRODUCTION 


251 


Capital Goods are Essential Agents of Production 

First of all, we should note that capital goods are indis¬ 
pensable to production, as production is carried on to¬ 
day, and as it must be carried on if the present popula¬ 
tion of the world is to obtain even the bare necessities of 
life. We are speaking now of capital goods, as distin¬ 
guished from money which is one form of capital. Of the 
four “agents of production” — land, labor, management, 
and capital goods — the last is the least understood, 
partly because the term continues to be used in different 
senses. Yet, to understand what we mean by that term 
throughout this discussion, we have only to distinguish 
in a general way between two classes of goods that we see 
about us every day. At home, we make use of our house 
and the things in it — chairs, potatoes, phonographs, 
magazines, cotton, gloves, coal, and the like. All these 
goods, as they are and where they are, directly satisfy our 
wants. Since we use them up solely for this purpose, 
we call them consumers’ goods. There are also factories, 
warehouses, and stores, containing these goods ready for 
distribution, as well as lumber, iron, paper, leather, and 
other materials ready to be made into finished products, 
together with machines, oil, coal, and other supplies that 
will be used up in the process of making goods, but will 
not be a part of the goods. All these things cannot satisfy 
our wants directly. This part of our national wealth, 
which is used as a means of producing more wealth, we 
call producers’ goods, or capital goods. 1 

A cotton loom and a bale of cotton are both capital 
goods. But there is this difference between them: the 
machine can be used for one purpose only: the raw mate¬ 
rial, on the other hand, is readily available for scores of 
uses. One is fixed capital: the other is free capital. Be- 


252 


MONEY 


tween them, a sharp distinction cannot readily be made. 
In general, however, fixed capital includes machines, fac¬ 
tories, warehouses, railroads, and other physical proper¬ 
ties that cannot readily be used for any other purposes. 
Free capital consists of goods on hand, including raw ma¬ 
terials such as copper, rubber, cotton, and all the wire, 
paper, bolts of cloth, and other finished and semi-finished 
supplies in the manufacturing and selling industries that 
are available for many uses. There is no accurate meas¬ 
ure of the free capital of the country. It may be in the 
vicinity of ten per cent of the total capital; at times, no 
doubt, it is less than ten per cent, and at times it may be 
more than ten per cent. The importance of free capital, 
however, cannot be measured in percentage figures, for 
much of our fixed capital is useless without an adequate, 
continuous supply of free capital. Without cotton and 
rubber, tire factories must shut down. 

Not only must we have capital goods, but constant 
supplies of fresh capital goods. When the factory whistle 
blows at the end of each working day, the building is 
more nearly obsolete and every machine in it is a little 
nearer the junk pile. This is one of those economic 
facts that are so obvious that their importance is con¬ 
stantly overlooked. It seems, sometimes, as though the 
abstruse problems of economics might some day be 
solved, if, first of all, we could see clearly those aspects of 
our industrial life that are as patent as the force of grav¬ 
itation. Accepted explanations of the physical world long 
ignored even the law of gravitation. Men may yet be in¬ 
duced, before promoting projects for the reorganization 
of the industrial world, to take into account the necessity 
for constant accumulations of fresh capital goods. 


MONEY IN PRODUCTION 


253 


Capital Goods are the Result of Saving 

Now it so happens that continuous accessions of both 
free capital and fixed capital will not be forthcoming un¬ 
less men have sufficient incentives to save; for capital re¬ 
sults only from saving. It is possible to gather spruce 
gum with the bare hands: it is much easier to use jack- 
knives. One is primitive production: the other is capital¬ 
istic production. Jackknives used in this way are capital 
— results of past savings. So are the elaborate buildings, 
furnaces, cutters, elevators, wrapping machines, and 
motor trucks that are used annually to supply fifty mil¬ 
lion people, more or less, with Wrigley products. The 
jackknives and the chewing-gum factories serve the same 
economic function. Both are surplus products of past ef¬ 
forts, saved in order that future efforts may be more pro¬ 
ductive. Unless somebody, sometime in the past, had 
consumed less than he produced, we should all have to 
gather gum, catch fish, plant corn, and defend ourselves 
from wild beasts without any more efficient tools than 
unfashioned sticks and stones. Unless many thousands 
of people had made large savings in the distant past, and 
unless people had continued to save generation after gen¬ 
eration, most of us would not have been born, and the 
rest of us would be struggling with nature for the barest 
means of subsistence. Our harvesting machines, cotton 
mills, telephone systems, railroads, and electric power 
plants would have been impossible. Indeed, the standard 
of living which is now regarded as a minimum of comfort 
and decency for everybody would have been beyond the 
reach of anybody. 

Standards of Living depend on Production 

Standards of living depend mainly on the volume of 


254 


MONEY 


production. Consequently it is futile to expect perma¬ 
nently to lift the standard of living of wage-earners as a 
whole by lifting the general level of wages. A cat does not 
get far while it is chasing its tail: to pursue living costs 
with wage increases is to follow a similar circle of futility, 
for the cost of living itself is determined mainly by wage 
schedules. The American Federation of Labor is right in 
declaring that ‘‘the practice of fixing wages solely on a 
basis of the cost of living is a violation of sound economy 
and is utterly without logic or scientific support of any 
kind.” All arbitrary wage awards are economic nonsense. 
Nothing we can do to wages will enable every one to ob¬ 
tain ten bushels of wheat if the per capita production is 
five bushels. “The significance of the Labor Movement,” 
says Mr. Hobson, “will continue to be misunderstood 
so long as it is regarded as a mere demand for a larger 
quantity of wages and of leisure, important as these ob¬ 
jects are. The real demand of Labor is at once more rad¬ 
ical and more human. It is a demand that Labor shall no 
longer be bought and sold as a dead commodity subject 
to the fluctuations of Demand and Supply in the market, 
but that its remuneration shall be regulated on the basis 
of the human needs of a family living in a civilized coun¬ 
try.” 2 As an ideal, this has merit: as a demand, it is ab¬ 
surd. The remuneration of labor is not based on ideals, 
but on goods. The hope of a higher standard of living for 
the people of any nation depends first of all upon a higher 
volume of production. 

This brings us back to our central theme; for it is the 
fact that workers are paid in money rather than in goods 
that tends to obscure their dependence upon capital and 
its efficient use in production. In the days when the ma¬ 
jority of workers were independent mechanics, or fisher¬ 
men, or hunters, or traders, it was easy for them to see 


MONEY IN PRODUCTION 


255 

the importance of “capital” and the relation between 
productivity and their own material welfare. But when 
the modern employer and money wages intervene be¬ 
tween the workman and his product, he is constantly in 
danger of making the mistake of thinking that, by inter¬ 
fering with the accumulation of capital goods and with 
their productivity, he can greatly injure his employer 
without greatly injuring himself. 

Savings are encouraged by Safety 

In order that man might emerge from savagery, it was 
necessary for him to do more than create surplus wealth. 
He had also to solve the difficult problem of devising 
means whereby surplus wealth could be safe and, at the 
same time, employed in the creation of more wealth. At 
the dawn of civilization, he partly answered this problem 
by the use of money. For a long time, he put his money in 
clumsy ironclad boxes, fastened with huge locks. To this 
day at Oxford, as George W. Gough reminds us, they talk 
of the University Chest, and in the Bodleian Library dis¬ 
play Sir Thomas Bodley’s chest. 3 In the United States, 
we talk nowadays about the Community Chest, but this is 
only picturesque language. When we save money for any 
purpose, we do not put it in a stout box where it would be 
useless and unsafe, but in a stout bank where it is both 
useful and safe. 

As capital goods depend on savings, so savings depend 
to some extent on the expectation of safety. The growth 
of capital goods — and consequently the increase of pro¬ 
duction and the raising of standards of living — are im¬ 
possible without security of property. We cannot expect 
men to sacrifice, and to save enough to meet the growing 
needs of mankind, if there is no assurance that, in the end, 
they will be allowed to enjoy their savings; any more than 



MONEY 


256 

we can expect men to work faithfully and long if there is 
no guarantee that in the end their wages will be paid. As 
soon as the Russian peasants found that their surplus 
wheat would be seized by the Government, they raised no 
surplus. It matters not what a man’s social theories may 
be. He finds no compensation for his loss in the thought 
that his property has been appropriated in the professed 
interests of the proletariat. What he has saved is gone: he 
will save no more. 

Continued Supply of Capital Goods depends on Profits 

After men refrain from consuming all that they pro¬ 
duce, and accumulate savings in the form of money, they 
must be induced to use their money to produce more 
wealth or to lend it to somebody who will so use it. The 
inducements are profits and interest. The fact that rich 
men invest their money, and thus become still richer, 
does not make them enemies of wage-earners. On the con¬ 
trary, most investors directly benefit wage-earners, for 
most of the money that they invest in stocks and bonds, or 
directly in factories and mines, is soon paid out in wages. 
Still more important is the fact that virtually all the 
money thus invested has an essential part in producing 
the wealth which alone makes possible higher standards of 
living for the wage-earners themselves, or even the main¬ 
tenance of existing standards. Civilization is in no danger 
because men strive to accumulate wealth: it would be 
doomed if they ceased striving. Real wages could not be 
as high as they are to-day unless many men had saved 
money and invested it profitably. 

Profits are often spoken of as though they were chests 
of money, and as though the country were in imminent 
danger of having all the money hoarded by a few men. 
In reality, private fortunes are mainly in various forms 


MONEY IN PRODUCTION 


257 


of capital — warehouses, ships, power plants, stores of 
copper, and so forth. As a rule, the only way in which 
they can add to the fortunes of their owners is through 
serving the needs of other people. The owners are not 
using them for their own enjoyment and will not take 
them away when they die. It is when men of wealth 
spend money freely, however, that they are applauded, 
particularly if they spend it on other people, or give it 
away. Yet the economic calamity would be the greatest 
in history if all men of wealth, regardless of the state of 
business activity, should use their money mainly in con¬ 
sumption instead of mainly in production. As a class, 
spendthrifts or unwise investors who lose their money 
do economic harm to the country; but, as a class, wise 
investors gain profits through the very act of helping the 
country. It follows that, in so far as men invest their in¬ 
comes profitably, they act as a rule as faithful trustees 
of wealth. This is as true of John Smith, a mechanic, who 
out of his savings buys and retains ^one share of stock 
in the Standard Oil Company, as it is of John D. Rocke¬ 
feller. Both men produce more than they consume. 
Consequently, as a rule, the more successful they are, 
the more they contribute to the material comforts of 
mankind. 

As a rule — but not always. As long as society enjoys 
the benefits which come from allowing its members much 
freedom of initiative, society must suffer to some extent 
from anti-social forms of initiative. Not all investors who 
make profits also promote public well-being. The profits 
may come from fraudulent enterprises, political corrup¬ 
tion, parasitic trades, and forms of speculation and of 
monopoly that are economically harmful. Society must 
always be on the alert to protect itself from the small mi¬ 
nority of its members who make it seem, to some people, 


MONEY 


258 

as though profits that arise out of harmful enterprises 
were the rule instead of the exception. 

They are not the rule. If a Workmen’s Council sud¬ 
denly found itself in absolute control of all industry in the 
United States, their first and most important task, in their 
own economic interests, would be to devise some means of 
inducing all men to continue to save their money and in¬ 
vest it in production; and the Workmen’s Council would 
discover, sooner or later, as Russia has already discovered, 
that the most effective means are the institutions of pri¬ 
vate property, interest, and competitive industry con¬ 
ducted for personal profit. 

The profits that result from the use of capital in produc¬ 
tion injure society economically to the extent that they 
are used in excessive consumption. And excessive con¬ 
sumption is bad whether it is by individuals or by govern¬ 
ments. But, as a matter of fact, most of those who receive 
large incomes spend small proportions of their incomes in 
personal consumption. Some of the men and women of 
great wealth, who have been most frequently condemned 
as public malefactors, have consumed for personal en¬ 
joyment less than one per cent of their profits. The rest 
of their profits have been used in the production of further 
wealth; and of this wealth, again, they, themselves, con¬ 
sume less than one per cent. This is a small price for 
society to pay for increased production. 

It might appear at first thought as though wage- 
earners, as a body, would have been better off if all the 
profits had been promptly disbursed as wages and if the 
growth of large fortunes had thus been prevented. It 
must be admitted that, if profits were more widely dis¬ 
tributed, and if those who received the profits saved them 
to the same extent and invested them as wisely as they 
are now saved and invested, the net result would be at 


MONEY IN PRODUCTION 


259 


least as large a volume of production as we now have. 
And there would be other gains. The fact is, however, 
that the savings which distinguish civilization from sav¬ 
agery, and which have made possible most of the material 
satisfactions of life, have been due chiefly to the volun¬ 
tary savings of a small proportion of the human race. If 
the products of industry had always been distributed 
equally and savings had been entirely at the option of 
each individual, there would have been nothing com¬ 
parable to the present accumulations of wealth. Conse¬ 
quently, the standard of living of wage-earners would 
have been far below what it is to-day. That is to say, 
savings have been forced upon the human race, not al¬ 
ways without doing injury to some workers, but on the 
whole for the immeasurable benefit of the race. 

This is true even though very large profits are made by 
producers and investors. Whether or not these profits ac¬ 
tually reduce the workers’ share in the products of indus¬ 
try depends on what is done with the profits. If the profits 
are reinvested promptly enough in directions dictated by 
the daily purchases of consumers, it is the people as a 
whole and not the investors who have the immediate en¬ 
joyment of the profits. For, in this case, most of the 
profits are soon disbursed as wages; and when the goods, 
for the production of which the wages have been paid, 
reach the markets, they are consumed mainly by wage- 
earners. This is not the whole story, by any means; and 
nothing we have said warrants the conclusion that the 
fruits of industry are now distributed in satisfactory pro¬ 
portions among all those who take part in the processes of 
production. All we wish to emphasize here is the fact that 
projects for a better distribution of wealth will be futile 
unless they take due account of the function of savings, 
capital investments, interest and profits in producing the 
wealth that is to be distributed. 


26 o 


MONEY 


We have now taken into account the main contentions 
of those who decry profits; but we have not yet mentioned 
the chief indictment that might well be made. Oddly 
enough, this has escaped nearly all the reformers. We 
concluded above that whether or not profits actually 
reduce the workers’ share in the products of industry de¬ 
pends on what is done with the profits. Now, in a period 
of rising prices, profits may be so employed as to pre¬ 
vent enough money from flowing into consumers’ hands 
to take away, at the current price-level, the commodities 
that have been produced. Thus, a lag in the flow of 
money from one use in consumption back to another use 
in consumption, due to certain dispositions of profits, 
may lead to business depression through causing a defi¬ 
ciency of purchasing power in consumers’ markets. But 
this subject we must postpone: we are encroaching upon 
the domain of our concluding chapters. 

Taxation may curb Growth of Capital Goods 

Taxation without representation may be tyranny; but 
taxation without production is impossible. When taxes 
are so levied as to prevent the growth of capital goods, 
and thereby to prevent increased production, they cut off 
the sources of further revenue. They kill the goose that 
lays the golden egg. Continued taxation requires the con¬ 
tinued replacement of old capital and accumulation of 
new capital, which is impossible when the unproductive 
expenditures of the Government run riot. No shoe man¬ 
ufacturer can extend or even maintain his production 
facilities, if he spends too large a proportion of his receipts 
in pensioning employees, in ornamenting his plant, and 
in policing it. No nation, no matter what the form of gov¬ 
ernment, can escape the same economic forces. They are 
no respecters of government. Production may be para- 


MONEY IN PRODUCTION 


261 


lyzed, not only by the autocratic control of absolute mon- 
archy, but as well by the irresponsible tyranny of de¬ 
mocracy. By means of direct taxation, or by means of 
illicit taxation through inflated currencies, or by means 
of military force, a government may seize and dissipate 
existing capital; but in the future it will find no means 
of seizing the wealth which it has thereby prevented its 
people from producing. 

It is necessary that the rich should be taxed, and it 
seems just that they should be taxed at a higher rate than 
the poor. Certainly nothing is gained by shifting taxes, 
directly or indirectly, from those who have large incomes 
to those who have small incomes, if the net result is to in¬ 
terfere with progress toward an ideal industrial order: if 
men and women are so impoverished that they cannot 
discover and apply continuously to the service of society 
their best abilities of body and mind. The point we are 
making is that higher taxes on the wealthy do not neces¬ 
sarily lighten the real burdens of the poor, and lower 
taxes on the wealthy do not necessarily increase the real 
burdens of the poor. If the problem were as simple as 
this, wage-earners could improve their condition at any 
time merely by voting to increase the taxes on large in¬ 
comes. But there are difficulties in the way. One, as we 
have said, is that the net result may be reduced produc¬ 
tion. Another is that all taxes from whatever source are 
spent by the Government. This would be no difficulty at 
all, if the Government always used the money more effi¬ 
ciently than private enterprises could use it in producing 
commodities and services for the enjoyment of its people. 
It is not certain, however, that money goes as far, dollar 
for dollar, toward satisfying human desires when spent by 
the Government as when employed in competitive indus¬ 
try : and whatever the Government wastes is a loss to all 


262 


MONEY 


the people, no matter where the money comes from. It is 
a greater injury, however, to the poor than to the rich, 
because it curbs their consumption of the necessities of 
life; whereas money taken from the rich in the form of 
taxes is taken chiefly from the amount that they would 
otherwise invest in further production. 

Money unlike Other Forms of Capital 

Money is a form of capital because it is used in the pro¬ 
duction of wealth. Money, however, is unlike other forms 
of capital, because an increase in the volume of money 
may or may not mean an increase in capital wealth. We 
cannot create wealth by writing credits on the books of 
the banks, any more than we can create theaters by print¬ 
ing a boundless supply of admission tickets. Again and 
again, our bankers have emphasized this fact. Banks can 
do no more, through the making of bank loans, than to 
give command over existing capital goods to those who 
can use them most productively. The common measure 
of the value of capital is in terms of dollars at current 
prices; but, as we have had occasion to observe over and 
over again, the identical machines, factories, stocks of 
wool, leather, and so on — which constitute our capital — 
may go up and down rapidly in dollar-value. As the 
money-value of capital goes up during a period of infla- 
tion, there is an increase in the volume of credit. It is 
easy to make the mistake of regarding such a vast in¬ 
crease in credit facilities as we had immediately following 
the World War as a vast increase in capital facilities. To 
guard against this error, we must distinguish carefully be¬ 
tween the actual physical goods and an increase in bank 
credit based upon these goods. 

We must also avoid the error of considering the produc¬ 
tion facilities of the country merely in grand totals. Fol- 


MONEY IN PRODUCTION 


263 


lowing the War, the facilities for the production of ammu¬ 
nition, chemicals, ships, and automobile tires were in ex¬ 
cess of the country’s needs. In order to estimate the ade¬ 
quacy of the capital equipment of the country at any 
given time, we must first subtract such excesses wher¬ 
ever they exist. A shipbuilding plant, upon which the Gov¬ 
ernment has spent ten million dollars, may be included 
at that figure in the estimate of the capital equipment of 
the country; whereas it may mean, economically, that 
ten million dollars have been diverted from profitable to 
useless channels. The extraordinary extension of capi¬ 
tal facilities in certain directions during the War and 
immediately after the War, and the extraordinary book 
profits of that period, led many people to overvalue the 
supply of capital in the United States. If we considered 
the proportions which should prevail among various 
forms of capital equipment for the purposes of peace-time 
production, and made allowance for the increase of popu¬ 
lation, we might find that the capital equipment of the 
United States, after the War, in proportion to the needs 
of the country, was actually inferior to the capital equip¬ 
ment before the War. 

The business depression of 1920 was due, in part, to 
business procedure based on overestimates of the existing 
volumes of real capital, real income, and buying capacity. 
Much that was regarded during the busy days of 1919 as 
increased wealth proved to be mere book values as soon as 
a downward movement was under way. From the out¬ 
break of the War in 1914 to the crest of prosperity in 1920, 
loans and discounts of the national banks in this country 
were approximately doubled. The individual deposits in 
reporting banks were also approximately doubled during 
the same period. In laying out production schedules, 
many business men, in one way or another, were misled 


MONEY 


264 

into regarding this extraordinary increase of bank de¬ 
posits as evidence of an extraordinary increase in wealth. 
Yet, during this period, taken as a whole, the increase in 
the production of wealth did not proceed much more 
rapidly than in the years before the War, when there was 
no extraordinary increase in bank loans, discounts, and 
individual deposits. From 1914 to 1920, according to one 
estimate, there was less than two per cent increase in the 
physical volume of capital goods. 4 

To meet the needs of production, there is enough 
money when the supply of credit is such as to bring 
about the best use of the supply of capital goods. In 
many countries, to-day, there is too much money to do 
business with; that is to say, the expansion of credit in 
spite of the destruction of capital goods has produced 
violent price-movements which have destroyed the use¬ 
fulness of money as a standard of value, broken down 
working relationships among the agents of produc¬ 
tion, and, consequently, still further increased the dis¬ 
crepancy between credit and capital goods. On the 
other hand, there would not be enough money for the 
purposes of production if capital facilities were really 
doomed to prolonged idleness solely because of credit 
stringency. 

In the recent experiences of Europe — since they have 
magnified economic phenomena several diameters by 
means of monetary inflation — the distinction between 
capital goods and credit is most clearly seen. From the 
outbreak of the World War until 1921, the volume of 
bank credit in France increased more than six hundred 
per cent, and in Germany more than six thousand per 
cent. In both countries, credit increased by leaps and 
bounds at the same time that capital goods were being 
daily destroyed. Indeed, generally speaking, throughout 


MONEY IN PRODUCTION 265 

Central and Eastern Europe, bank credit has increased 
and capital goods have decreased. 

Money an Essential Agent of Production 

Land, labor, management, and capital goods are essen¬ 
tial agents in production. But evidently there are other 
essentials. During the year 1918, the United States 
reached its maximum production: during the year 1920, 
production came nearer to a standstill than ever before. 
Yet there was just as much land in 1920 as in 1918, just 
as many laborers, just as many managers, just as much 
capital goods. There was the land, waiting to be tilled; 
there were the laborers, even more eager to work than be¬ 
fore, for their needs were greater; there were the mana¬ 
gers, even more competent than formerly, for they had 
learned from adversity; and there were the closed fac¬ 
tories, empty freight cars, idle power plants, silent ship¬ 
yards, about as fit to carry on as in the busiest days of 
1918. Something essential to production was lacking, and 
that something was the vitalizing force of money in actual 
use. 

The individual producer must have money wherewith 
to buy and maintain his fixed capital in the form of land, 
buildings, machines. He has constant need of money to 
pay for coal, oil, and other supplies which are used up, 
as well as for raw materials and semi-finished products, 
for which he may receive nothing until they are embodied 
in finished goods and sold and paid for. To meet still 
other needs, he must keep on hand a daily cash balance. 
He must have money also to meet emergencies: he does 
not always receive enough for the products of previous 
months, or receive it promptly enough, to pay the oper¬ 
ating expenses of the current month. His expenses may 
outrun his receipts, because of seasonal or cyclical flue- 


266 


MONEY 


tuations in his own business; or because of the misfortunes 
of his customers; or because during a shut-down expenses 
go right on, though receipts may dwindle or stop. Above 
all, the producer must have money for his pay-roll. The 
laborers must be paid to-day, even if the goods they are 
working on are not sold for many months. The individual 
wholesaler also needs money. In order to take advantage 
of the market, and to be prepared to fill orders promptly, 
he must buy at times in advance of known demand. It is 
part of his business to take these risks. For this purpose, 
he must have additional money. Similarly, the producer 
of raw material must incur expenses in advance, often 
years in advance, of the sale of his products. In order 
that manufacturers may have rubber and hides this 
month, somebody for many years has had to pay the op¬ 
erating expenses of plantations and ranches. 

It is true that the retail merchant may obtain addi¬ 
tional book credit from the wholesale merchant; who, in 
turn, may be granted further credit by the manufacturer; 
who, in the same manner, may pass along some of the ex¬ 
tra burdens to the producer of raw materials; who, in this 
emergency, may apply to his bank for a new loan. But 
this passing-on process is merely a device for tempo¬ 
rarily meeting the costs of production, mainly wages: 
somewhere, sometime, consumers have to spend enough 
money to meet all the pay-rolls or (as we hope to make 
clear in succeeding chapters) production must cease. 
Book credits do not pay wages, and even for other pur¬ 
poses they are only short-time aids. Recourse to banks is 
also only a temporary expedient. The whole elaborate or¬ 
ganization of production and consumption is predicated 
on the assumption that in due time the consumer will 
have enough actual money to pay all the bills all along the 
line. In short, no matter how abundant the supplies of 


MONEY IN PRODUCTION 267 

land, labor, management, and capital goods may be, pro¬ 
duction cannot go on without money. 

At this point in our discussion we may well revert for a 
moment to the meaning of the rate of interest. From 
what we said in our chapter on that subject, and from the 
commonplace observations we have just made concerning 
the necessity of money in production, it is evident that 
general economic progress requires interest rates that will 
encourage constant accumulations of fresh capital; that is 
to say, rates high enough to induce men to run the neces¬ 
sary risks in lending money, yet low enough to encourage 
enterprisers to borrow money. This is precisely the level 
toward which interest rates constantly tend when not sub¬ 
ject to arbitrary Government interference. 

Summary 

When we consider that our material necessities and 
comforts of life depend mainly on production; that pro¬ 
duction requires constant accumulations of fresh capital 
goods; that these accumulations are impossible without a 
medium of exchange; that capital goods, even after they 
have been accumulated, cannot be employed in produc¬ 
tion without the use of money; we see clearly that money 
is far more than “a mere convenience” — far more than 
“a contrivance for sparing time and labor.” Without 
money, rightly employed, most of the machinery of pro¬ 
duction stops and labor is unemployed. As well call the 
machinery itself a mere convenience, or the directing 
brains of industry a mere convenience. When several 
agents are all indispensable for a given purpose, there is 
little profit in discussing their relative importance. Here, 
again, we may miss the point if we follow the counsel of 
those who insist that we must look beyond the mere me¬ 
dium of exchange to '‘the real wealth which it repre- 



268 


MONEY 


sents.” If we are to explain such economic phenomena 
as the post-war business expansion and subsequent de¬ 
pression, it is upon money in its relation to real wealth 
that we must focus our attention. Money is essential in 
production: that fact, in itself, will continue to urge upon 
us the necessity for further studies of money. 5 


CHAPTER XVI 

MONEY ADVANCED IN PRODUCTION 


Periodically, extreme competition among buyers, stim¬ 
ulated by rising prices and sustained by expanding bank 
credit, is followed by what is called overproduction; 
namely, a volume of production so large that the con¬ 
sumers’ purchasing power is insufficient to take the goods 
off the market at prevailing prices. At once, the whole 
machinery of production and distribution slows down. 
Then the index of business activity, as pictured in Figure 
I of our opening chapter, falls; and the dark area of eco¬ 
nomic loss expands. The question should be thoroughly 
investigated to what extent and under what circum¬ 
stances this cyclical movement is associated with what 
we may call the time-factor in production. By the time- 
factor we mean the period elapsing between the day when 
wages are paid in connection with the production of goods, 
and the day when the goods are placed on the market for 
the production of which the wages have been paid. 

Let us consider, in detail, this time-factor in pro¬ 
duction. Take, for example, the total goods — shoes, 
gloves, automobiles, plows, and so forth — placed on the 
markets of the world during any one month, say, April. 
These goods could not have been produced, as we have 
just observed, unless money had been paid to numerous 
people far in advance. For a large proportion of these 
goods, wages were paid to the producers and distributors 
in January, or earlier. This prepayment would cause no 
serious complications if there were, as men have often as¬ 
sumed, an even flow of purchasing power in the other 


270 


MONEY 


direction all the way around the circle — wage-earners to 
retailers, to wholesalers, to producers, and thence back to 
wage-earners. But on account of price-fluctuations, and 
resultant speculative buying and withholding of goods, 
and miscalculation of consumers’ demands, and changes 
in production due to all these causes, only rarely are the 
goods placed on the market in April exactly equal in 
volume to the goods placed on the market in January 
— that is to say, at the time of the creation of that pur¬ 
chasing power. Therefore, there is seldom a perfect ad¬ 
justment between current purchasing power and current 
goods. In other words, there is a fluctuating relation be¬ 
tween present effective consumers’ demand and supply 
previously created. 

The Gap between Current Consumption and Current Produc¬ 
tion 

Until we know the consequences of this gap between 
current output and current consumption, we are liable 
to neglect certain economic phenomena of major impor¬ 
tance. These consequences are not apparent, however, if 
we consider only current conditions. In 1921, the Presi¬ 
dent of an important National Bank in New York 
City spoke effectively of the present “serious malad¬ 
justment between the production and consumption of 
current goods.” 1 But he did not thereby direct attention 
to the basic difficulty. The serious maladjustment is not 
between current production and current consumption. 
There is a current maladjustment, to be sure, since, in a 
period of depression, consumption exceeds production. 
When four million men are unemployed, they are pro¬ 
ducing nothing; but they are helping to use up the stocks 
on hand. At such times, however, excess of consumption 
over production is not serious: it is salutary. It is not 



MONEY ADVANCED IN PRODUCTION 271 

to be deplored, for it is the necessary preparation for 
increased business activity. It is the price we pay for 
overproduction in the past. It is to some extent the re¬ 
sult of a maladjustment, created months before, between 
purchasing power disbursed at that time as wages and 
goods previously produced, which was then looked upon 
as prosperity. And it is this antecedent maladjustment 
that deserves most attention. Money — especially bank 
credit — has made it possible on a scale previously incon¬ 
ceivable. 

This maladjustment is due to the fact that producers 
can pay for labor and material with their savings in 
money or with newly created bank credit, while they are 
making and holding more goods than the market will take 
at prices sufficient to induce them to continue produc¬ 
tion. This could not possibly go so far under a system of 
barter, because the volume of goods a producer could 
store up, at any one time, and succeed in exchanging for 
the particular labor and materials he needed for the pro¬ 
duction of more goods, would be comparatively small. 
Even if workers were paid in goods previously accumu¬ 
lated, wages would have at least a definite limit, for the 
maximum goods available for wages could not be more 
than the actual store of exchangeable wealth; and this 
would be comparatively small because of the costs and 
risks enumerated above. 2 Thus there would be an inflex¬ 
ible upper limit, far below the upper limit of purchasing 
power that can now be created through the expansion of 
bank credit. Therefore, under a barter economy, fluctua¬ 
tions in the ratio of consumers’ goods and consumers’ 
demand, due to the time-factor that we are now consid¬ 
ering, would be slight. 

The crux of the matter is this: under a system of barter, 
buyers could not get hold of what appeared to be a valid 


272 


MONEY 


claim upon vastly more than the total stock of goods in 
existence. Elastic currency and bank credit, on the other 
hand, make payments possible which have no fixed rela¬ 
tion to the store of wealth, or to the goods currently reach¬ 
ing the markets, or to the goods currently produced. 

Money advanced to increase Capital Facilities 

Our modern financial and industrial organization of 
society is such that, for years at a time, men may make 
daily, effective demands as consumers without themselves 
supplying any consumers’ goods. When such demands 
increase rapidly, as they do when the construction of new 
capital facilities is financed by means of the expansion of 
bank credit, the result — unless offset in some way — is 
a consumers’ demand in retail markets that is not yet 
met by increased supply. That such a result came in the 
United States following the War is not surprising when 
we consider the rate of growth of capital authorized in 
connection with new corporations and the parallel expan¬ 
sion of bank credit. For seven years previous to 1919, the 
amount of such capital did not greatly exceed three bil¬ 
lions of dollars a year. During 1919, however, the amount 
was above twelve billions, and during 1920 it was above 
fourteen billions. 3 These figures have to do only with the 
capital of new enterprises. There were also vast increases 
in the capital of established concerns. Suppose we assume 
that scarcely half these additions to authorized capital 
quickly reached the markets as buying power. Even so, 
since the growth of capital came largely through expan¬ 
sion of bank credit, these corporations, new and old, were 
putting a huge new dollar-demand into the retail markets 
in advance of new goods. 

In many cases, the discrepancy between wages paid 
and goods placed on the market is more than a question 


MONEY ADVANCED IN PRODUCTION 273 

of time. Especially during periods of rapid business ex¬ 
pansion, there are likely to be many pay-rolls that do not 
at any time lead to the production of goods that will sell 
for enough to cover the pay-rolls. The United States 
Government, for example, built 285 wooden vessels at a 
cost of $230,000,000 and sold them for $430,000. The net 
result was to place more than four hundred dollars of ef¬ 
fective demand in the markets for every dollar of supply. 
With similar results, one of our construction companies 
built a rolling mill on Staten Island for $5,000,000 and, 
before turning out any product, scrapped the mill for 
$35°> 000 * The more there are of such projects, not 
financed out of savings, in the initial stages of a period 
of business expansion, the more difficult it becomes for 
supply of goods to catch up with increased dollar-demand. 

There is no such difficulty when new construction is 
paid for out of savings. Thousands of men, for example, 
were engaged in constructing the Panama Canal. After 
two years of hard labor, they had moved vast quantities 
of earth and had thereby contributed to society a long, 
deep ditch, which was of no use to anybody: it was not 
yet ready for ships. Nevertheless, throughout the two 
years, the men who dug the ditch had received money 
regularly and were thereby enabled to make daily, effec¬ 
tive demands upon the stocks of consumers’ commodi¬ 
ties. Since, however, the wages of these men were paid 
mainly by means of taxation which did not involve ex¬ 
pansion of bank credit, what these consumers spent was 
taken from other consumers, and the construction of the 
canal did not tend to unbalance supply of commodities 
and demand for commodities. 

The Time-Factor and Overproduction 

A period of prosperity continues until the productive 


274 


MONEY 


agencies of the country reach the highest efficiency they 
will attain. When this point comes, few men are aware of 
the fact, because the volume of commodities offered for 
sale does not indicate either the large volume in the mak¬ 
ing or the invisible supply in the hands of speculators. 
Failure to sense the coming glut is due in part to the wide 
geographical distribution of markets for the same com¬ 
modities and of producers for the same market, to Gov¬ 
ernment restraint upon trade associations, and to lack of 
publicity concerning current stocks and commodities in 
process. On account of the time it takes to produce com¬ 
modities and get them into the shops, the markets do not 
feel the full effects of maximum productivity until months 
after that stage has been reached. Production, therefore, 
continues at a high rate; and the volume of commodities 
coming upon the market, as a result of loans previously 
made, continues to increase. Many producers do not 
foresee that the pace cannot continue indefinitely, and 
some of those who perceive that this is true of other lines 
of business believe that it cannot possibly be true of their 
own. In any event, while profits are unusually high, they 
believe that they can afford to carry unusually large 
stocks of materials: and, as deliveries become more un¬ 
certain, they must carry even larger stocks all along the 
line from raw materials to finished products, if produc¬ 
tion is to be uninterrupted. As there is a limit, however, 
to the expansion of bank credit, the time comes when 
there is a decrease in the amount of money, advanced by 
banks to producers, that reaches consumers’ hands. Pres¬ 
ently, therefore, the consumers’ purchasing power is in¬ 
sufficient to buy the increased volume of products at pre¬ 
vailing prices. Then there is said to be overproduction; 
prices break; goods scurry out of hiding like rats from a 
sinking ship; business finds, all along the way from deal- 


MONEY ADVANCED IN PRODUCTION 275 

ers in raw materials to retailers, that smaller stocks will 
suffice for daily needs; prices fall abruptly; a crisis or a 
period of depression follows; men and women are thrown 
out of work; and business is again on the downward 
swing of the cycle. 

Workers are not paid in Goods 

Thus, due consideration of the time-factor in produc¬ 
tion reveals another case in which the assumption that 
money is of little importance obscures what actually goes 
on in the domain of commerce. In a mistaken attempt to 
make simple that which is in reality exceedingly complex, 
many writers have insisted that, since workers are really 
paid in goods, the use of a medium of exchange for wage 
payments may be ignored. But workers are not paid in 
goods: they are paid in money. Ultimately, it is true, they 
are paid mainly in goods; but time is the essence of our 
difficulty: for, as we have just seen, the fact that work¬ 
men are first paid in a medium having the characteristics 
of money and the fact that this medium becomes a de¬ 
mand, not upon the goods they are making, but upon 
goods already finished and in retail markets, appear to 
be connected with the major difficulties of the business 
world. 

The question is pertinent, therefore, to what extent and 
under what circumstances general overproduction and 
business depression are associated with advanced pay¬ 
ments in production. The answer to this question de¬ 
pends in part on the extent to which the effects of the 
time-factor are modified by overbuying, speculation, in¬ 
crease of capital facilities, exchange of ownership of capi¬ 
tal goods, profit rates, interest rates, changes in the wage- 
level, and foreign trade. The answer also depends in part 
on the stage in the upward or downward swing at which 


276 


MONEY 


these various influences become effective. Quantitative 
and time studies of some of these factors are as yet 
too fragmentary for our purpose; although, fortunately, 
several new research agencies are now at work in this 
field. 4 But already the conclusion seems warranted that 
the answer to our question depends mainly on the extent 
to which the factors we have mentioned and others in¬ 
fluence the volume of money daily spent in consumption. 
To that subject, we shall now turn. 


CHAPTER XVII 

MONEY IN CONSUMPTION 

Money spent in the consumption of commodities is the 
force that moves all the wheels of industry. When this 
force remains in right relation to the volume of com¬ 
modities offered for sale, business proceeds steadily. 
When money is spent faster than the commodities reach 
the retail markets, business booms forward. When com¬ 
modities continue to reach the retail markets faster than 
money is spent, business slackens. To move commodi¬ 
ties year after year without disturbing business, enough 
money must be spent by consumers, and no more than 
enough, to match all the commodities, dollar for dollar. 
Otherwise, there is sure to develop presently either a glut 
or a shortage, a resultant change in the price-level, and a 
tendency toward business depression. In short, produc¬ 
tion looks for its regulator to distribution; and distribu¬ 
tion in turn is regulated by the flow of money through 
consumers’ markets. 

Consider first the results of this regulation in a period 
of relatively stable prices. In such a period, unless con¬ 
sumers continue to spend as much money as usual for 
shoes — to take a typical consumers’ commodity — re¬ 
tail shoe dealers do not buy as usual from distributors. 
Unless retail dealers continue to buy as usual from dis¬ 
tributors, distributors do not buy as usual from shoe 
manufacturers. Unless distributors keep on buying shoes, 
manufacturers do not keep on buying leather. Unless 
they buy leather, tanners do not buy hides. Thus, once 
the consumer has failed to do his usual part in taking away 


278 


MONEY 


the finished product, there is a piling up, all along the line, 
of raw materials, semi-finished products, and finished 
products. There is, in consequence, all along the line, 
a curtailing of production, a reduction of pay-rolls, and 
a cumulative deficiency of consumers’ purchases. The 
same effects are felt in the markets for producers’ com¬ 
modities. If the people curtail their purchases of shoes, 
the manufacturers make fewer shoes. Consequently, 
they reduce their orders for shoe machinery. Producers 
of shoe machinery, therefore, modify their scale of opera¬ 
tions and reduce or entirely stop their orders for pig-iron 
and other raw materials. Thus, when consumers buy less 
than usual, they put a brake upon the whole series of 
operations, in the domain of producers’ commodities as 
well as in the domain of consumers’ commodities, all the 
way back to the ranch and the mine. 

All this is equally true of a period of rising prices. 
Moreover, in such a period the difficulty of moving all the 
commodities that are produced becomes greater because 
of the fact that current production is never planned to 
satisfy current demand: always it is planned to meet an 
expected demand that may not materialize when the 
commodities are ready for sale. When prices are rising 
production schedules and costs are predicated upon an 
expected, increased demand — upon a continued rise in 
prices. At every stage in the production process from the 
ranch to the retailer, everybody is eager to take full 
advantage of a rising market. As a result, the cost and 
scale of operations come to be regulated not, as in a period 
of relatively stable prices, with reference to the expected 
continuance of the present dollar-demand of retail buyers, 
but with reference to the larger anticipated dollar-demand. 
When production is thus regulated, it cannot continue at 
the prevailing level of volume and costs without a con- 


MONEY IN CONSUMPTION 


279 


tinned increase in the amount of money spent by con¬ 
sumers. In 1920, for example, consumers could not meet 
the expectations of producers merely by spending as 
much as in 1919. Depression followed. All of which 
brings us again to the conclusion we reached in a previous 
chapter. Inflation calls for further inflation: it is a drug 
habit. Once business has become dependent upon an 
artificial stimulus, new doses must be injected or business 
will suffer depression. 

Thus, whether the price-level is stable or changing, it 
is the amount of money spent for consumers' commodities 
that determines the state of business activity. 

That is the fundamental reason why the business men 
of this country are concerned lest the nations of Europe 
should pay their debts to us in commodities. “Let us 
figure to see whether the payment of these debts," said 
Thomas W. Lamont, “which inevitably must mean a 
great increase in our import and a heavy decrease in our 
export trade, is going to prove an asset or a liability for 
American business." 1 Why a liability? Are not gloves 
from France real wealth, and olive oil from Italy, and 
cutlery from England? Can there possibly be any danger 
of importing more European products than we can enjoy? 
The idea seems absurd. As long as we pay no attention 
to possible monetary complications, we see no reason to 
worry over the prospect of acquiring real wealth. Here, 
again, if we ignore “the money surface of things" and 
focus our attention on commodities, we overlook the key 
to the whole situation. But when we consider the fact 
that in this case the process of importing commodities 
would not put into the hands of consumers the money 
wherewith to buy those commodities, and a period of fall¬ 
ing prices and business depression might ensue, we see 
that the net result of importing real wealth might be 


280 


MONEY 


economic injury. All because money — an instrument 
which men designed for their own convenience — incon¬ 
veniently stands in the way of the uninterrupted enjoy¬ 
ment of the wealth which they have created. 

Only Money spent in Consumption can sustain Production 

As no force except money spent in consumption can 
sustain production, year in and year out, we may here 
confine our attention to the volume of commodities that 
pass into consumers’ hands through the medium of 
money. In our day, as we have observed, 2 the volume 
of commodities moved by barter trading is insignificant. 
By no means insignificant, as we have pointed out, 3 is 
the volume moved on open-book account. But such an 
expedient is only temporary. Presently there must be 
money payments or no further movements of commodi¬ 
ties. Under a money economy, no large influences can 
continue to bring about marked fluctuations in the state 
of business activity unless they change the relation of the 
amount of purchasing power spent in the consumption of 
commodities to the volume produced. 

This is contrary to the widespread belief that if a suf¬ 
ficient number of people talk prosperity with sufficient 
enthusiasm, they can bring on a commercial revival that 
will be sustained by its own momentum. The sunshine 
cure for business anaemia overlooks the function of the 
buyer in business and the only conditions under which he 
can continue to buy. Artificial respiration cannot keep 
the patient alive indefinitely. A spirit of optimism can¬ 
not long create or sell commodities: it cannot of itself oper¬ 
ate a blast furnace nor take shoes off the retailer’s shelves. 
It must first induce somebody to spend money. To per¬ 
suade business to prepare for an effective consumers’ de¬ 
mand that is not forthcoming merely makes matters 


MONEY IN CONSUMPTION 


281 


worse. At certain times, it is true, business is not unlike a 
machine on a dead center: once started by a push from the 
outside, it can go on by itself. But this happens only 
when something more substantial than the booster’s 
spirit has increased the consumers’ purchasing power. At 
best, optimism can do no more than start a forward move¬ 
ment a little earlier than it would otherwise have started. 
Business cannot run on optimism. Many upward turns 
in stock markets, as well as in copper and cotton markets, 
are due to states of mind; but reactions soon occur unless 
mere expectations are justified by real purchasing power. 
A self-starter may save time in starting an engine, but 
only a steady supply of gasoline can keep it running. Sun¬ 
shine campaigns may start business, but only consumers’ 
dollars can sustain it. 

Production schedules, to be sure, are based on estimates 
of future market conditions; and these estimates are af¬ 
fected by the state of public confidence in the business 
outlook; and public confidence tends to rise or fall cum¬ 
ulatively. This whole process is described with singular 
clearness and amenity by F. Lavington, in “The Trade 
Cycle.” “Rising confidence,” he says, “increases the 
supply of effective purchasing power, and increased pur¬ 
chasing power by raising prices gives a further impulse to 
the growth of confidence. The three are mutually related. 
Each reinforces the others and is reinforced by them.” 4 
This is no doubt true. Indeed, the three factors are so in¬ 
tricately and continuously related that it may seem aca¬ 
demic to try to determine which is the most important. 
We are inclined, however, to give much less prominence 
than Mr. Lavington gives to the factor of confidence and 
much more to the factor of purchasing power, and this 
for the practical reason that fluctuations in the volume of 
purchasing power are much more amenable to sustained 


282 


MONEY 


public control, as well as for additional reasons which we 
may be able to explain by means of the author’s analogy 
of the small boy who goes skating. 

When the boy comes to a pond where many people are 
skating, he has no fears: parental warnings are forgotten. 
It does not occur to him that the larger the number of 
skaters, the greater is the risk. On the contrary, the more 
skaters there are, each apparently confident that the ice 
will sustain him, the greater is the confidence of all. Then 
comes a loud crack. Suddenly general confidence be¬ 
comes general apprehension: fear is contagious and cu¬ 
mulative. The efforts of everybody to escape at once re¬ 
sult in a panic. Similarly, when all business men seem to 
be extending their operations, placing larger orders, and 
bidding up prices, the confidence of each increases the 
confidence of all. It does not occur to them that the more 
there are who are skating on thin ice, the greater is the 
danger of a crack. When the crack does come, apprehen¬ 
sion spreads quickly: the fear of each increases the fear of 
all. Then, in their sudden efforts to reach safe financial 
ground, they may bring on a panic. 

This is a sound analogy, as far as it goes; but it does not 
warrant the conclusion that confidence is the main factor 
in sustaining a revival of business, or lack of confidence 
the main factor in prolonging a period of depression. We 
know perfectly well that not even the buoyant confidence 
of youth would enable the small boys to keep on gliding 
over the pond if the ice failed to do its part. We know, too, 
what most of the small boys would do, after the terrifying 
sound of the cracking ice had driven them ashore in a 
panic: they would try the ice again to see if there were 
really any cause for fear. If the crack in the ice proved to 
be a false alarm, fear would vanish and the skating would 
continue. Similarly, if business men were fearful that the 


MONEY IN CONSUMPTION 


283 


daily purchases of consumers would become insufficient 
to sustain business, and if consumers, nevertheless, kept 
right on buying, business men would soon get over their 
qualms, and business would go on as before. 

It is true that confidence and rising prices and increased 
purchasing power have intricate causal relations: each 
sustains the others and is sustained by them. It is easy, 
however, to overestimate the importance of confidence. 
Confidence cannot continue to increase the purchasing 
power of consumers if the ratio of gold reserves or any 
other cause checks the growth of the actual volume of 
money in circulation, or the proportion of new money 
that reaches consumers; and a rise in prices cannot long 
continue without increased purchasing power of con¬ 
sumers. In short, prices and confidence cannot rise far 
without the support of continued increases in purchasing 
power; but continued increases in purchasing power, at 
least when a gold basis gives assurance of a definite limit 
of inflation, can continue to lift the levels of prices and 
confidence. 

Commodity Markets the Center of Interest 

Money is spent for services as well as for commodities, 
for dentists as well as for candy and toothpowder. We are 
not overlooking that fact. But, as far as business depres¬ 
sions are concerned, there are four reasons why we should 
focus our attention on commodities rather than on serv¬ 
ices. First and most important is the fact that more of 
the workers of the world are engaged in the production of 
commodities than in all other occupations combined. In 
the second place, unemployment is a far more serious 
problem among producers of commodities than among 
producers of services. This is due to the fact that the 
world can live for months on stored-up products, but it 


284 


MONEY 


cannot get along for a day on stored-up services. To¬ 
day’s craving for candy can be satisfied from surplus 
stocks, while the men who made the candy are out of 
work; but to-day’s toothache calls for the services of a 
dentist to-day. Consequently, industrial depressions be¬ 
gin in the markets for commodities rather than in the 
markets for services. In the third place, the maximum 
employment of those who make commodities seems to be 
prerequisite, in the long run, to the maximum employ¬ 
ment of many of those who render services. It is the work 
of the butcher, the baker, and the candlestick-maker that 
enables society to employ the teacher, the butler, and the 
vaudeville star. Finally, payments for personal serv¬ 
ices are transfers of purchasing power between consumers. 
In themselves, they do not change either the volume 
of money offered for commodities or the volume of com- 
. modities offered for money. It does not necessarily make 
much difference to business as a whole whether a man 
spends a certain amount in consumption or in hiring a 
chauffeur who spends it in consumption. The total sup¬ 
ply of commodities and the total demand for commodi¬ 
ties remain the same. For all these reasons, business ac¬ 
tivity depends primarily upon the amount of money that 
is spent for commodities. 

Standards of Living depend on Sustained Production 

Standards of living depend on sustained production — 
not on low prices or high prices, low profits or high profits, 
low wages or high wages, low interest rates or high interest 
rates. Generally speaking, and apart from obvious quali¬ 
fications, prices, profits, wages, and interest rates serve 
the economic interests of society in so far as they do their 
part in stimulating and maintaining production. Upon 
the continued operation of the going economic machine of 


MONEY IN CONSUMPTION 


285 


this year’s model, most of us depend for the material com¬ 
forts of life. “We may be mildly interested,” as M. C. 
Rorty says, “in knowing what the 1930 or 1950 model of 
industrial machine is to be, but it is of downright serious 
importance to have a full gas tank and oil reservoir and 
all cylinders firing on this year’s model. Furthermore, to 
continue the parallel, we are not half so much concerned 
with whether the machine will make sixty miles an hour 
on a level stretch, as we are with its ability to keep going, 
uphill and downhill, at an ordinary road speed and to 
come home at night under its own power.” 5 The achieve¬ 
ments of most men and women who are accounted suc¬ 
cessful are due, not so much to occasional strokes of gen¬ 
ius, as to industrious persistence, year in and year out, in 
the pursuit of definite aims. We could get along very well 
without the brilliant spurts of business if it would only 
demonstrate a capacity for sustained effort. 

The maximum productivity that is continuously pos¬ 
sible is most likely to be maintained when there are no 
sharp fluctuations in the state of business activity. Under 
such conditions, therefore, business yields to mankind, 
year in and year out, the largest possible volume of con¬ 
sumable commodities — the largest means for main¬ 
taining a high standard of living. And that is what busi¬ 
ness is for. It is well to remind ourselves frequently that 
business as a whole exists, not for wages or profits, not for 
keeping men employed or keeping prices at certain levels 
— these are incidentals — but for the maximum produc¬ 
tion and distribution of goods. Further implications of 
this aim will appear in later chapters; for the present it is 
enough to bear in mind that the attainment of this aim 
requires first of all sustained production. 


286 


MONEY 


Producers’ Commodities and Consumers’ Commodities 

If we are to understand the essentials of sustained pro¬ 
duction, we must distinguish between producers’ com¬ 
modities and consumers’ commodities. By the latter, we 
mean those commodities the using up of which is an end 
in itself, as distinguished from those which are used up in 
the process of making other commodities. Thus, rubber 
and cotton, when used by a household merely for the sat¬ 
isfaction of the family, are consumers’ commodities; but 
rubber and cotton, when used in a tire factory, are pro¬ 
ducers’ commodities. The wearing out of a cotton loom 
is a part of the process of production; the wearing out of a 
cotton shirt is a part of the process of consumption. This 
classification — as we observed in the second chapter — 
is not logically precise and final: some commodities that 
are consumed by the individual for his own satisfaction — 
food, for example — add to his efficiency as a producer; 
some commodities — steel rails, for example — are used 
by consumers and producers at the same time. The dis¬ 
tinction is adequate, however, for our present purposes; 
and, in accordance with this distinction, the terms “ con¬ 
sumer/ ’ “consumption,” and “consumers’ commodities” 
will be used throughout this discussion. 

In order that production may be sustained, the output 
of consumers’ commodities must be taken off the retail 
markets at not far from the current price-level. Theoret¬ 
ically, the price-level could go up indefinitely and quickly 
without upsetting business; but actually, as the price- 
level goes up, money spent in consumption fails presently 
to keep pace with the supplies that arrive on retail mark¬ 
ets. This is partly because in time it becomes necessary to 
stop expanding bank credit or to abandon the gold basis. 
In either case, business depression follows sooner or later. 


MONEY IN CONSUMPTION 287 

It is equally true that the output of producers’ com¬ 
modities must be taken off the markets at not far from 
the current price-level; for we are concerned not only 
with consumers’ expenditures, but also with the distribu¬ 
tion of money between producers’ markets and consum¬ 
ers’ markets. Upon this relationship depends sustained 
activity in the wholesale wool trade as well as sustained 
activity in the retail clothing trade; and this ig true of 
business as a whole. However, activity in tl^rnarkets 
for producers’ commodities as a whole is liRfely to be 
maintained if just enough money is continuously %pent 
in consumption to dispose of finished products at current 
prices. For if there are no marked fluctuations in the ef¬ 
fective demands of consumers, there are no incentives for 
producers as a whole greatly to curtail or to expand busi¬ 
ness. Consequently, we may well focus attention upon 
conditions that affect the amount of money spent in con¬ 
sumption. 

It may be said that there is still another requirement 
for sustained production: there must not be an unbalanc¬ 
ing of the distribution of demand among various branches 
of consumers’ markets. That is to say, there must not be 
sudden changes in the character of demand. This, how¬ 
ever, is a secondary requirement. It is true that, during 
a boom period, a few leading industries may fail to sell 
their output at the high prices that they must obtain 
because of high costs of production; and to some extent 
their difficulties may be passed on, through credit en¬ 
tanglements and unemployment, to many other indus¬ 
tries. A cumulative process of liquidation and restricted 
buying, thus started, may help to spread trouble through¬ 
out the business world. This fact, however, need not 
discredit our emphasis upon the relation between con¬ 
sumers’ incomes as a whole and the production of com- 


288 


MONEY 


modities as a whole: for it seems improbable that a 
number of leading industries, at the same time, would 
suddenly find themselves unable to sell their products, 
and quickly pass on their troubles to other industries, if 
the total consumers’ demand remained sufficient to take 
away the total production at the current price-level. The 
needs and tastes of consumers, as a whole, do not change 
rapidly enough to bring about such violent changes in the 
characterof consumers’ demand. So long as consumers’ 
incomesjlSas a whole, keep pace with production as a 
whole, it is difficult to see how a few leading industries 
could get themselves into such inextricable difficulties as 
to cause a general collapse of business. When a collapse 
does come, it is not mainly because troubles peculiar to 
wool markets or automobile markets cause troubles in 
other markets, but because of deficiencies in consumers’ 
purchasing power in general , which naturally bring dis¬ 
aster first in one place and then in another. 

Wages which facilitate Consumption 

Still further to analyze the causes of fluctuations in the 
relation of consumers’ demand to new consumers’ com¬ 
modities, we may distinguish between wages, like those of 
household servants, which are paid to facilitate consump¬ 
tion, and wages, like those of mill operatives, which are 
paid to facilitate production. Upon this distinction was 
based one of the popular propositions of the old ly- 
ceum — the question whether it is an advantage to so¬ 
ciety for men to employ, on their private estates, addi¬ 
tional butlers, cooks, gardeners, and coachmen. The 
question was never fully answered, for it was not consid¬ 
ered in connection with the state of business. Any change 
in the relative amounts paid to those who aid in produc¬ 
tion and to those who aid in consumption tends to change 


MONEY IN CONSUMPTION 289 

the balance between commodities produced and com¬ 
modities consumed. This is a change of immediate eco¬ 
nomic importance. Whether a proportionate increase in 
the total wages of those who aid consumption is good or 
bad for business depends on the state of business. When 
prices are falling, such an increase is good for business; 
when prices are rising, it is bad for business. Unfortu¬ 
nately for the interests of sustained production, pay¬ 
ments to this class of workers fluctuate in the wrong 
direction. Chauffeurs, for example, are laid off precisely 
when business revival would be aided by additional un¬ 
productive consumers who spend money freely. Conse¬ 
quently, these fluctuations are an added stimulus to busi¬ 
ness when business is already overstimulated and an 
added depression to business when business is already 
overdepressed. 

The Flow of Consumers , Incomes 

The amount of money which will be spent in consump¬ 
tion in a given period of time depends largely upon the 
amount of money in the control of consumers and avail¬ 
able for use in consumption. The flow of consumers’ in¬ 
comes is increased whenever there is an increase in the 
total volume of money in circulation. This total is in¬ 
creased when (1) additional metal comes from any source 
and is coined and placed in circulation, or (2) additional 
paper money is placed in circulation, with or without ad¬ 
ditional reserves, or (3) the volume of bank credit is in¬ 
creased. Bank credit, by far the largest of the three, is 
increased, for the most part, only when somebody bor¬ 
rows money for one of the following purposes: (1) for the 
payment of labor and materials needed in the production 
of goods; (2) for carrying stocks over to better markets; 
(3) for payment of debts; (4) for use in stock exchange 


290 


MONEY 


speculation; (5) for the extension of capital facilities; 
(6) for payment of wages, salaries, pensions, or bonuses 
to Government employees or beneficiaries; (7) in order 
that retailers may extend credit to their customers. It is 
important to bear in mind that most of the newly created 
money is first used in production or in speculation. It 
takes some time for it to reach consumers. 

It is true that deposits subject to check are sometimes 
increased on account of loans for immediate use in con¬ 
sumption. To some extent, the borrowing of money by 
consumers on insurance policies and mortgages involves 
expansion of bank credit. It is clear, also, that the adop¬ 
tion of the Bonus Bill that was passed by the House of 
Representatives in 1922 would have increased consumers’ 
incomes through the expansion of bank credit for loans to 
ex-soldiers. It is true, furthermore, that the money dis¬ 
bursed by European governments as pensions, bonuses, 
and doles is used at once mainly in consumption. Ordi¬ 
narily, however, the total volume of bank loans for con¬ 
sumption purposes is exceedingly small compared with 
the total volume of loans for productive and speculative 
purposes. As a rule, therefore, consumers’ incomes are 
only slightly increased by the expansion of bank credit 
before the new funds have first been used for non-con¬ 
sumption purposes. How long it takes for newly created 
money of any kind to get around to use in consumption, 
what factors determine the time taken by money in the 
circuit flow from consumer back to consumer, and what 
happens in the meantime to the price-level are ques¬ 
tions which have not yet been adequately considered. 
That appears to be one reason why we have no adequate 
analysis of business cycles. 


MONEY IN CONSUMPTION 


291 


There is no Fixed Consumers 1 Fund 

The conception of a flow of consumers’ income will be 
misleading unless we guard against the error of thinking 
of this income as though it were a definite amount of 
money available for the purchase of consumers’ goods 
and for nothing else. There is no such fund as this, any 
more than there is a wage fund in the old use of that term. 
The total current purchasing power is all the money in 
the hands of the people, in savings banks, or subject to 
check, or elsewhere, which is available for consumers’ 
goods and services and for capital disbursements; but at 
no time is this grand total made up of a consumers’ fund 
and a producers’ fund, the one available only for the pur¬ 
chase of consumption goods and the other available oniy 
for the purchase of production goods. On the contrary, 
nearly every individual buyer has at least some option 
every day with reference to the proportion of money on 
hand that he will spend in consumption, the proportion 
that he will invest, and the proportion that he will retain 
in his pocket. 

On the one hand, nearly all the money that is spent for 
producers’ goods might be spent for consumers’ goods: 
nearly every one who invests money in a lumber mill, 
either directly, or indirectly through buying bonds or 
stocks, or making deposits in banks, has the option of 
spending all or part of it for household furniture. On the 
other hand, in the United States at least, only a part of 
the money that might be spent in consumption must be so 
spent: virtually every one, if necessary, could save more 
money. Compared with what we daily buy and daily 
consume, the minimum requirements for sustaining life 
are small, as we know from the tragic experiences of 
Europe. The consumption of millions of people in Europe 


292 


MONEY 


has been reduced to half what it was before the War; and 
even before the War, the per capita consumption of the 
Continent was far below that of the United States. It is 
possible, therefore, permanently to curtail the average 
daily expenditure in the United States. Furthermore, it 
is possible for a short time to reduce current expenditures 
far below the amount which in the long run is a minimum 
requirement for consumers’ commodities. We can wear 
our old clothes, postpone repairs on the house, and use up 
surplus food supplies. Consequently, there is at no time 
a fund of definite amount which has to be used in con¬ 
sumption, either at once or ultimately; nor is there at any 
time a fund of definite amount which we have any means 
of knowing will be used in consumption, either at once or 
ultimately. On the contrary, a large number of unmeas¬ 
urable influences, mainly states of mind, are constantly 
at work, varying greatly in degree and even in direction, 
which determine what proportion of the consumers’ in¬ 
come, in any given period, actually will be used in con¬ 
sumption. 

“ The Buyers’ Strike ” 

This brings us to certain psychological aspects of the 
subject. Are not changes in the mental attitudes of con¬ 
sumers as important as changes in the size of consumers’ 
incomes? Many people seem to think so. They contend 
that variations in the number of dollars that consumers 
have to spend is no more important than variations in 
their willingness to spend what they have. “All depres¬ 
sions,’’ says John H. Van Deventer, “are at first psycho¬ 
logical, in other words, caused by fear existing in the 
mind only. Fear causes a cessation of buying — not a re¬ 
duction of buying power; the money to buy is at hand, but 
the buying stops. No depression is made permanent or 



MONEY IN CONSUMPTION 


293 


real until this fear leads to unemployment which does 
away with the money wherewith to buy.” 6 The British 
consumer in 1920, according to C. H. Northcott, “mani¬ 
fested a psychological reaction against high prices. It is 
his refusal to buy that is the root of the slump in Great 
Britain.” 7 The depression of 1921, in the United States, 
which is said to have resulted from a “Buyers’ Strike,” is 
also cited to show the importance of the state of mind of 
the consumer. At that time, it is said, millions of con¬ 
sumers, as a protest against “profiteering,” refused to 
spend their money. This was a common explanation of 
the origin of the depression. In editorials and magazine 
articles, the decline in sales was generally attributed to a 
more or less concerted determination of final consumers 
to withhold their dollars because they thought prices 
were outrageously high. 

Sufficient evidence to support this view is lacking. In 
the first place, the theory fails to explain why the buyers 
did not “strike” in 1919. Were they generally satisfied, 
at the end of 1919, with prices eighty-five per cent above 
the pre-war level, but pretty generally outraged, six 
months later, because in the meantime prices as a whole 
had risen about ten per cent? This does not sound reason¬ 
able. The “Buyers’ Strike” explanation does not explain 
what we are most eager to understand; namely, why the 
depression came precisely when it did come. 

Nor does this theory explain, in the second place, what 
became of all the money that the outraged buyers are said 
to have withheld from the market. Are we to suppose 
that they carried it in their pocketbooks in addition to 
the usual amounts? Only a small part of the depression 
could be accounted for in this way. Undoubtedly, there 
were some indignant citizens who refrained from buying 
certain articles solely in protest against the high prices 


294 


MONEY 


of those articles. One man, for example, refused to pay 
fifty dollars for a suit of clothes. What did he do with the 
fifty dollars? That is the main question. Did he spend 
it for a chair? If so, his action helps to explain the falling 
off in clothing sales, but does not help to prove that there 
was a general “ Buyers’ Strike.” Indeed, there could have 
been no continued general depression if consumers’ in¬ 
comes had continued to grow at the same rate, and if all 
the money withheld from '‘profiteers” had been passed 
over the counters of other dealers. 

In further support of the theory of the “Buyers’ 
Strike,” it is said that the dollars which were refused to 
merchants were turned over to savings banks or left in 
checking accounts. This explanation, however, fails us in 
two ways. It is faulty, first, because money turned over 
to savings banks is not long withdrawn from circulation. 
The most that can be said is that its use in consumption 
is delayed, because the greater part of it becomes avail¬ 
able for consumers’ goods only after the banks have 
loaned it to producers and they in turn have disbursed it 
in wages and in other payments. Thus its circuit time 
from consumption to consumption is lengthened. It is 
true, therefore, that depositing money in banks that 
would otherwise be spent in stores temporarily reduces 
the amount spent in consumption. But only temporarily. 
This explanation of the “Buyers’ Strike” is faulty, in the 
second place, because in 1920 there were no increases in 
the volume of bank balances subject to check. On the 
contrary, total deposits fell. 

Further evidence that the amount of money available 
for use in consumption is the chief factor in determining 
the amount that is actually spent in consumption is fur¬ 
nished by statistics of money in circulation compared 
with statistics for retail trade. During the years 1914 to 


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13. Sales at Retail compared with Sales at Wholesale 

1919-192! 










































MONEY 


296 

1921, fluctuations in the dollar-values of retail sales cor¬ 
responded closely with fluctuations in the total amount of 
money in circulation. It is also worth noting that taxes 
from the sale of cigarettes, which toward the close of 1919 
were in excess of fourteen million dollars a month, had 
fallen a year later below eleven million dollars a month. 
During the same period taxes on smoking and chewing 
tobacco fell from a monthly rate of about five millions to 
a rate of three millions. This decline in sales can hardly 
be attributed to a strike among smokers. It is more likely 
that sales of cigarettes and smoking and chewing tobacco 
serve as a fairly reliable measure of the rise and fall of 
consumers’ incomes. 

The Depression of 1920 not due to a “ Buyers’ Strike” 

The “Buyers’ Strike” explanation of the depression of 
1920 falls short not only in these particulars, but also be¬ 
cause the depression was not initiated by final consumers. 
That their purchases were fairly well sustained long after 
dealers had all but stopped buying is shown in Figure 13. 8 
The dollar-value of retail sales in the second Federal Re¬ 
serve district (New York) in the spring of 1921 was about 
the same as in the spring of 1920. 9 Retail sales were also 
well sustained in rural districts. The gross business of the 
Sears-Roebuck Company, for example, nearly all on a 
cash basis, was $254,000,000 in 1920. It was not until the 
fall of 1920 that the sales of this mail-order house slumped 
so seriously that new financing became necessary: in 1921 
the gross business was only $178,000,000. It was the 
wholesale dealers who first reduced their orders to a min¬ 
imum; and they did so, not as a protest against rising 
prices, but because they expected prices to fall. As soon 
as prices did begin to fall, dealers waited for the bottom. 
“When the crash came,” says E. M. Herr, of the West- 


MONEY IN CONSUMPTION 


297 


inghouse Electric and Manufacturing Company, “we 
stopped all buying of all kinds.” 10 This policy prevailed. 
This was the real buyers’ strike: it was a postponing of 
buying by purchasing agents who expected lower prices. 
This movement went so far that many large producers 
telegraphed small orders, from day to day, for delivery by 
express, in order not to buy any more than was abso¬ 
lutely necessary on a falling market. 

The farther we look into the depression of 1920, the 
clearer it becomes that the general decline in buying be¬ 
gan with dealers rather than with consumers. It was due 
in the first instance to conditions which culminated in the 
curbing of the expansion of bank credit and the fear of a 
collapse of prices, rather than to any such concerted 
protest against high prices as might properly be called a 
buyers’ strike. And the expansion of bank credit would 
have come to an end, even without pressure from the 
Federal Reserve Board; for lack of confidence in the fu¬ 
ture would have led to the withdrawing of bank deposits. 
It seems equally clear that the falling off in sales to final 
consumers, which was inconsiderable until later on, was 
due only in small measure to high prices, but mainly to 
lack of funds. People who want to buy and have no 
money should be compared with the unemployed rather 
than with strikers. The “ Buyers’ Strike” is one of those 
clever catch phrases which, like cartoons that appeal to 
the imagination, often pass current as proof of the point 
at issue and thus help to fasten a fallacy upon a nation. 
No doubt some final consumers with funds at hand re¬ 
fused to buy merely because prices seemed to them too 
high; but their refusal was a minor factor in the markets, 
and was insufficient to bring on a depression, as long as 
consumers’ incomes were large enough to take away cur¬ 
rent production at prevailing prices and there was a wide¬ 
spread belief that prices would be still higher. 


CHAPTER XVIII 

THE CIRCUIT FLOW OF MONEY 

Sustained production, we have just observed, depends 
largely upon sustained daily expenditures for consumers’ 
commodities. The volume of these expenditures depends 
mainly on the size of consumers’ incomes. The size of these 
incomes depends mainly on the total volume of money 
in circulation. But this is not the only factor. The size 
of consumers’ incomes is also determined in part by the 
frequency with which money, once spent in consumption, 
is returned to consumers; that is to say, the average time 
taken by money to make the circuit from expenditure 
by consumers through various uses back to another ex¬ 
penditure by consumers. The flow of money, therefore, 

from use in consumption to another use in consumption 

« 

should not be overlooked in studies of the causes and 
conditions of business fluctuations. What we have come 
to call the business cycle is a composite of many cycles — 
cycles of wage rates, wholesale prices, farm rents, profits, 
volume of production, growth of capital facilities, and 
so on. Among these periodic movements are cyclical 
variations in the circuit flow of money. These we should 
study separately, while bearing in mind the fact that 
they are not the only important cyclical phenomena. 

It is the purpose of this chapter to describe certain 
aspects of this circuit flow of money, to raise the question 
whether it does not deserve more attention than it has 
yet received in our analyses of business cycles, and to 
suggest pertinent lines of investigation. Unfortunately, 
the statistics upon which the most important conclu- 


THE CIRCUIT FLOW OF MONEY 


299 


sions concerning this subject must be based are not at 
hand and are not likely to be for some time to come. The 
following discussion will have served its purpose if it 
stimulates further inquiry in profitable directions and 
helps to hasten the day when the necessary statistics are 
available. 

The Circuit Flow of Money and Commodities 

There are streams of commodities and streams of money 
which, in a literal sense, are constantly, though not stead¬ 
ily, moving in opposite directions. As Simon Newcomb 
long ago observed, 11 the influence of changes in the mone¬ 
tary circulation upon the well-being of the community 
is to be determined by their effects upon the industrial 
circulation.” For the most part, raw materials are 
grown, extracted and graded, moved on to factories and 
prepared for final consumers, moved on to wholesalers, 
thence distributed to retailers, and finally turned over 
to consumers. At the same time, streams of money are 
moving in the opposite direction — a main stream be¬ 
coming smaller and smaller as it flows from consumers to 
retailers, from retailers to wholesalers, from wholesalers 
to manufacturers, from manufacturers to producers of 
raw materials, and thence, mainly in the form of pay¬ 
ments for personal services, back once more to con¬ 
sumers. This circuit movement characterizes the flow 
of money, but not the flow of commodities. When com¬ 
modities get into the hands of the consumers, they are 
usually disposed of; thus they are withdrawn forever 
from the stream. On the contrary, most of the money 
that reaches the consumer is paid by him to retailers 
and to others; and thence it proceeds around the circuit. 

The stream of money from use by consumers in the 
purchase of new goods back to another use by con- 



300 


MONEY 


sumers in the purchase of new goods, we shall call the 
‘'circuit flow of money.” The average time taken by 
money in making this round through the various streams, 
we shall call the “circuit time of money.” Its rate of 
flow we shall call the “circuit velocity of money.” The 
circuit velocity is the reciprocal of the circuit time. If, 
for example, the circuit velocity is two times a year, the 
circuit time is one-half year. 

The Velocity of Money 

We are not now speaking of what economists call the 
“velocity of money.” By that term, they mean the fre¬ 
quency with which money is used for any purpose what¬ 
ever; that is, its turnover within a given period of time. 
Obviously, without due consideration of the velocity of 
money, no discussion of monetary problems is complete; 
for one dollar spent ten times, if spent on the same day 
and for the same purpose, has about the same effect as 
ten dollars spent once. “The nimble sixpence,” says 
the proverb, “does the work of the slow shilling.” 1 In 
any given period of time, the amount of money actually 
spent is the product of the quantity of money and its 
velocity. But before we can determine exactly how the 
movements of money affect business, we must consider 
certain phases of the circulation of money — particularly 
the circuit velocity of money — that may be as signifi¬ 
cant as the velocity of money as a whole. If the volume 
of new commodities moving into consumers’ hands main¬ 
tained a definite ratio to the total volume of commodities 
in circulation, the circuit velocity of money would tend 
to bear a definite ratio to the velocity of money as a 
whole. In that case we should have no special interest in 
the circuit velocity of money. But our entire discussion 
is based on the assumption that these definite ratios are 


THE CIRCUIT FLOW OF MONEY 


301 


not maintained for any considerable time. We assume, 
on the contrary, that all periods of major business dis¬ 
turbances are characterized by an upsetting of the ratios 
that hold in times of relative business stability. 

The equation of exchange which takes into account 
only the velocity of money in general takes no account 
(as we explained in Chapter X) of some of the specific 
causes of business fluctuations. For some purposes, the 
general equation MV = ^pq is not as useful as the equa¬ 
tion MC = 2 pq , in which C is the circuit velocity of 
money. 2 We should consider separately changes in the 
velocity of money spent for consumers’ commodities and 
changes in the velocity of money used in other ways. 
When, as in 1919 (see Figure 14) 3 bank deposits are 
turned over more rapidly in connection with increased 
sales on the New York Stock Market, there may or may 
not be a corresponding change in the turnover of bank 
deposits to pay for consumers’ goods. Nor is money 
spent more frequently in retail markets merely because it 
is spent more frequently in wholesale markets. Money 
may work faster in order to pass woolen goods through 
more hands on their way to clothiers’ shops, without pass¬ 
ing more garments through the shops. In other words, 
additional middlemen may make use of money without 
making additional sales to consumers. Both velocity and 
quantity of money might remain constant — that is to 
say, people might have the same amount of money and 
spend it as rapidly as ever — and yet the markets might 
sense trouble. For if people decreased the amount spent 
for new goods within a given period of time, and to the 
same extent increased the amount spent in other ways, 
they would thus decrease the circuit velocity of money; 
and they might thereby temporarily depress business, 
without decreasing the velocity of money. Under cer- 


302 


MONEY 


tain conditions, therefore, the turnover of money as a 
whole may have less to do with business fluctuations 

ANNUAL RATE 



than the turnover of money in its particular function of 
moving goods into the hands of consumers. 

It is manifestly impossible to predict the course which 
a given coin will take from use in consumption back to 
another use in consumption. Even if we knew exactly 
what course it had just taken, we could not know what 
















THE CIRCUIT FLOW OF MONEY 


303 


course it might next take; and it would be exceedingly 
difficult to find out. To follow accurately a single circuit 
of even a small part of our currency — our silver dollars, 
for instance — would require much of the time of the 
entire population and thus interfere with their circula¬ 
tion. We can, however, study the factors that tend to 
change the circuit velocity of money as a whole. 

Within how long a period of time a volume of money 
equal to the total volume in circulation 4 will be spent by 
consumers depends upon the circuit time of money. In 
other words, whether the money spent in consumption is 
more or less than the total volume of money in existence 
depends on the length of the period we are considering. 
In a certain sense, it is true, all money is idle except 
when it is actually being used in exchange; but in that 
sense only one dollar out of many thousands is active, 
and all the rest are idle, in any given minute. It is only 
a matter of convenience which conception we employ. 
Either, if used consistently, leads us to the same conclu¬ 
sions as the other. 

Diagram of the Flow of Money 

The diagram on page 305, similar in plan and purpose 
to one devised by M. C. Rorty, 5 represents, in a general 
way, the circuit flow of money. To find fault with this 
diagram from an engineering standpoint would not be 
difficult; neither would it be sensible. All we should ask 
of these reservoirs and pipes is that they serve the pur¬ 
pose at hand. In the main, subject to certain qualifica¬ 
tions to be made presently, this diagram does serve our 
present purpose. It shows what the flow of money would 
be if business and bank credit were perfectly stable. 

The double reservoir at the top shows the amount of 
money in the hands of individuals and available for ex- 



304 


MONEY 


penditure in consumption. The reservoir is divided into 
two parts in order graphically to represent the fact that 
a part of the money received by individuals is income, 
most of which is spent in consumption; while a part is 
money received from the sale of real estate, bonds, and 
stocks, most of which is reinvested. The two parts of the 
reservoir, however, are connected with pipes, in order 
to take account of the fact that some income is invested 
and some money received from the sale of securities is 
spent in consumption. These connecting pipes are im¬ 
portant. We must bear in mind that they are always 
partly, and never wholly, clogged. By their aid, we may 
visualize the fact, mentioned in the previous chapter, 
that we have no means of knowing how much of the con¬ 
sumers’ incomes actually will be spent in consumption in 
any given period of time. 

Into the right-hand section of the consumers’ fund, 
three large pipes are emptying: one represents the large 
proportion of individual incomes, about seventy per cent, 
which is derived from personal services; the others repre¬ 
sent the smaller proportion, about thirty per cent, derived ' 
from management and property, including rentals, royal¬ 
ties, interest, and dividends. These percentages are the 
averages, in round numbers, of the figures for 1909-1918, 
found in the admirable study of Income in the United 
States , published in 1921 by the National Bureau of 
Economic Research. The sizes of some of the pipes in 
the diagram, however, are based, necessarily, on much 
rougher estimates. No dependable study has yet been 
made of the proportions of individual incomes which are 
spent for new commodities, services, real estate, and 
investments. 

Leading out of the reservoir of consumers’ incomes are 
various pipes which represent expenditures for rent, taxes, 


THE CIRCUIT FLOW OF MONEY 



Figure 15 

























































































































































































































































































































































3°6 


MONEY 


clothes, food, sundries, and wages. The relative, esti¬ 
mated amounts spent for these various purposes are in¬ 
dicated approximately by the size of the pipes. It will 
be observed that most of the individual incomes are paid 
at once to those who are engaged in the distribution of 
finished commodities. These distributors, in turn, pay 
much of the money they receive directly to manufac¬ 
turers, who, in turn, pay much of the money they receive 
directly to producers of raw materials. All along the way 
some of the money, mainly in the form of wages, profits, 
and interest, gets into the hands of individual consumers 
and is spent for consumers’ goods, thus completing the 
circuit flow. 

Some of the money completes the circuit quickly, some 
of it, slowly. As shown in the diagram, a part of the 
consumers’ income is spent directly for personal services 
and a part is paid to individuals for second-hand auto¬ 
mobiles and other “old commodities,” and is thus passed 
directly from one consumer to another. Most of the 
money spent by consumers, however, takes a longer 
course before it finds its way back to consumers. Part of 
the money that is spent for new commodities — a pair of 
shoes, for example — goes to the wholesaler; part of that 
money goes to the manufacturer; part of that money goes 
to the tanner; part of that money goes to the farmer who 
raised the stock; part of that money goes to the producer 
of harvesting machinery; part of that money goes to me¬ 
chanics in the factory, and is thus returned to consum¬ 
ers. During the circuit from consumer back to consumer, 
some of the money spent for the pair of shoes passed 
through more hands than in our illustration; some 
of it passed through fewer hands. The part that the 
retail shoe dealer paid immediately in weekly wages 
to his clerks made the circuit quickly. The part that was 


THE CIRCUIT FLOW OF MONEY 


307 


set aside in cash as undivided profits of the shoe manu¬ 
facturer may have taken a long time to make the circuit. 
It is the average time taken by all the money in the flow 
from one use in consumption to another use in consump¬ 
tion that we have called the circuit time of money. 

The Flow of Money and the Flow of Commodities 

Upon the rate of flow of money into the reservoir of 
personal incomes largely depends the even flow of com¬ 
modities from producer to consumer. The stream of 
money is, in fact, a line of communication. Money has 
often been compared with roads. Adam Smith even 
went so far as to anticipate this age of aeroplanes: he 
called money “a sort of wagon way through the air.” 
He emphasized the fact that money is unlike factories 
and stores. Rather, it is like railroads and telephones; 
for its function is not to produce or to exchange com¬ 
modities, but to facilitate their production and exchange. 
It is only a means to an end. 

Nevertheless, anything that happens to any of our lines 
of communication so as to disturb the even flow of com¬ 
modities can retard production and distribution. At 
times some of our freight cars get side-tracked and lie 
idle; some get diverted from more essential to less essen¬ 
tial uses. Now and then a bridge falls down and traffic is 
held up. Sometimes transportation facilities fail to meet 
increasing needs, as they did throughout the United 
States during the car shortage of 1920. Whatever thus 
prevents the orderly movement of commodities tends 
to prevent further production. 

Similarly, whatever interferes with the monetary lines 
of communication — that is to say, whatever retards the 
even flow of money from consumers back to consumers 
— tends to retard the flow of commodities and thus to 


3°8 


MONEY 


disturb business as a whole. Some money gets side¬ 
tracked in hoards, in cash balances, even in banks, and is 
unemployed for an unusually long time; some money gets 
diverted at times from more essential to less essential 
uses. Now and then a bank fails, and there is a sudden 
stoppage of the trade movements that were dependent 
upon the tied-up funds of the bank. Sometimes consum¬ 
ers’ incomes are increased out of proportion to increased 
production, as they were throughout the world in the 
years following the War. At other times, not enough 
money flows into consumers’ hands to maintain the pro¬ 
duction-consumption equation: the volume of finished 
commodities increases more rapidly than the volume of 
consumers’ expenditures. In short, whatever happens 
to the medium of exchange at once affects the whole 
industrial world in some way; whatever prevents the 
circulating purchasing power from moving commodities 
to final consumers interferes with further production. 

Variations in the Rate of Flow 

What it means to business to have variations in the 
rate of flow of money into consumers’ hands may be 
seen if we continue to think of consumers’ incomes as 
water in a vast reservoir. The simile need not mislead 
us if we keep in mind the fact that it proves nothing, and 
if we take care not to work it too hard even for illustra¬ 
tion. Let us observe, then, that some of the water in the 
reservoir moves through conductors to the turbines of 
electrical plants, whence power is transmitted to distant 
cities where it moves street cars, lifts elevators, runs 
washing-machines, cures diseases, illuminates buildings, 
and in a thousand other ways sustains the activities of 
complicated modern life. Some of the water moves 
through irrigating ditches to innumerable farms where it 


THE CIRCUIT FLOW OF MONEY 


309 


turns barren wastes into fields of wheat. Some of the water 
runs through mills where it moves machines that make the 
wheat into flour. Some of the water moves in river beds 
where it has its part in carrying the wheat and the flour 
from those who have a surplus to those who have none. 
Thus, at all times, a large part of this current supply of 
water is doing economic work. 

At times, on the other hand, a part of this water 
supply has no share in production and distribution — 
does no economic work whatever. At times, some of it 
stays on the surface of the reservoir in the form of ice; 
it is seasonally unemployed. Some of the water, after 
turning the wheels of industry at one place, moves on 
down the river until it breaks through the bank and 
comes to a stop in a dead basin. Thus it is withdrawn 
from the channels of commerce; it can do no more eco¬ 
nomic work until somehow it is released and again set in 
motion. There is another portion of the supply in the 
reservoir that is completely lost to industry; it evaporates 
before it has been used in any way. And there is still 
another portion that evaporates along the routes of com¬ 
merce, after it has played a part in the world’s work. 
Whatever thus disappears by evaporation is subtracted 
from the current supply of power; the loss is made good 
only when the power is re-created, as it is when the rain 
falls and the water flows again into the reservoir. 

Stability in production, as far as it depends on this 
water supply, is concerned only with the rate of flow . 
Nothing that happens to the water supply can upset pro¬ 
duction schedules provided the net result is an even flow 
of power, day in and day out, in the same channels, per¬ 
forming an unvarying amount of work. How much or 
how little of the water supply evaporates, or leaks from 
the pipes, or remains frozen in the reservoir, or is held 


3io 


MONEY 


back in dead basins, is of no consequence, provided the 
total volume thus withheld from industry and its dis¬ 
tribution remain the same. Only changes count. Until 
there are changes in the rate of flow, the work done will 
be plotted on the graphic chart as a straight line. 

Similarly, business stability, as far as it depends on 
money, is concerned primarily with the rate of flow of 
money into consumers’ hands. As far as stability is con¬ 
cerned, it does not necessarily make any difference how 
much money is in Government vaults, or is frozen in 
loans, or is idle in hoards, or is carried in pockets and tills 
as daily cash balances, provided the volume of money 
thus withheld and the volume of commodities coming 
upon the markets remain the same from day to day. Only 
changes count. 

Business stability, to be sure, is not the be-all and the 
end-all of the economic organization of society. The su¬ 
preme end is the satisfaction of human needs. The eco¬ 
nomic organization of society, in order progressively to 
adapt itself to larger human needs, must bring about a 
higher per capita production. But production cannot be 
sustained at higher levels without business stability. 

At any and all times, a change in the circuit velocity of 
money tends to cause a change in the state of business. 
Whether the change is good or bad for business depends 
on the state of business at the time. This appears to be 
overlooked in much that is said about “economizing 
credit,” “making money more efficient,” and “bringing 
hoards out of hiding.” It was an error, for example, 
while the general price-level was rising rapidly in 1919, 
to urge, in the interests of business, that higher rates of 
interest be paid for deposits in Postal Savings Banks in 
order to bring “a billion dollars out of hiding.” The usual 
assumption seems to be that anything that increases the 


THE CIRCUIT FLOW OF MONEY 


3ii 

velocity of money in general, or the amount spent by con¬ 
sumers, is advantageous to business in general. It may 
be good or bad for business. It all depends on economic 
conditions at the time and the nature of the transactions 
that are effected by the increased “efficiency” of money. 

The Circuit Time of Money 

How long does it take, on the average, for each dollar 
to make this round from one use in consumption to an¬ 
other use in consumption? What factors retard or accel¬ 
erate the flow? What are the effects of these fluctuations 
on the state of business activity? What are the corre¬ 
lations between changes in the velocity of money and 
changes in the circuit velocity of money? We shall now 
venture to open up the discussion of these questions in a 
preliminary way, though it may be many years before 
research will answer these questions as definitely as they 
must be answered before any one can account in full for 
the ups and downs of business. 

What is the circuit time of money? The available sta¬ 
tistics are not a sufficient basis for an answer to this ques¬ 
tion. If we use Professor Fisher’s estimate of the volume 
and velocity of money in the United States, in the year 
1909, and if we then, from the estimate of the National 
Bureau of Economic Research for the income of that 
year, guess at the value of new goods bought by con¬ 
sumers, we arrive at an estimate of the circuit time of 
money. 6 If the total money transactions for that year 
were $400,000,000,000, and the total amount of money 
in circulation was $8,680,000,000, the average velocity 
of money was approximately 46. If consumers spent 
$20,000,000,000 for new commodities during that year, 
the circuit time of money was 8,680,000,000 divided by 
20,000,000,000, which gives .434 years, or 158.4 days. 


312 


MONEY 


On the basis of these figures, the circuit velocity of money, 
the reciprocal of the circuit time of money, would be 
approximately 2.3. This would mean that for every 
dollar spent by a consumer for new commodities during 
1909, approximately nineteen dollars were used for other 
transactions. That is to say, although each dollar was 
used about once in every eight days for some purpose or 
other, it was used only once in 158 days for the purpose 
of passing new commodities into the hands of consumers. 
But there is so much guessing in these figures that they 
are useful only for illustration. If the turnover of bank 
deposits subject to check is now twenty-five or thirty 
times a year, as estimated by the statistical division of 
the Federal Reserve Bank of New York, the figures for 
velocity in our illustration are far from right. Our re¬ 
search agencies, no doubt, will provide us some day with 
more dependable estimates than any now available for 
the velocity of money and for the annual expenditures of 
consumers for new commodities. 

Defects in the Diagram 

Evidently, in order to represent all the uses of money in 
the course of its journey from consumer back to con¬ 
sumer, we should need a much more complicated diagram. 
It would be so complicated, in fact, that without a vast 
amount of study it would be confusing rather than clari¬ 
fying. For that .reason, we have not shown many of the 
money movements of minor importance. 

Nor have we shown all the movements that are of 
major importance. The reader has already observed, no 
doubt, that the diagram overlooks the fact that nearly 
all money, on its way from consumer to consumer, passes 
through banks. Up to this point, we have directed atten¬ 
tion to the place in the circuit flow of money where it is 


THE CIRCUIT FLOW OF MONEY 


313 


spent by consumers. We have made this the center of 
our interest because consumption is the end for which 
commodities are created; and because we wish to raise 
the question whether anything that happens to money in 
any other part of the circuit can cause a major disturb¬ 
ance in business, as long as just enough money continues 
to be spent in consumption to take away commodities 
without a change in the price-level. There is good reason, 
however, for paying special attention to that part of the 
circuit in which money flows through the banks; for it is 
literally true that most of the money that is spent in con¬ 
sumption begins and ends its career in a bank. When 
a farmer who is waiting for his wheat to mature applies 
to the bank for a loan of ten thousand dollars, the bank 
increases its deposits to that extent, minus the discount. 
The total volume of money in circulation is thereby in¬ 
creased. As soon as the farmer spends the money, it 
proceeds on its way around the circuit. In due time, if 
all goes well, the farmer sells his wheat and pays the 
loan at the bank, thereby reducing the amount of money 
in circulation by ten thousand dollars. Thus, in a sense, 
most of our money is created and extinguished in the 
banks. 

It is sometimes said that the money is not extinguished 
by the paytnent of a loan, since, ordinarily, the bank is 
at liberty, the moment the loan is paid, to lend precisely 
the same amount to another borrower. The fact that the 
bank passes on the purchasing power by means of differ¬ 
ent pieces of paper is said to make no difference. When 
a bank loan is paid, however, the amount of the loan is 
actually withdrawn from the circuit flow of money; and 
an equal amount is returned to the stream only by a new 
joint act of the bank and a borrower. Unless we think 
of bank deposits as being thus created, and extinguished, 


314 


MONEY 


and re-created, we leave out of account one of the chief 
causes of fluctuations in consumers’ incomes. If all the 
money that flowed into the banks flowed out again at a 
constant rate, the banks could be omitted from the dia¬ 
gram, because they would neither retard nor accelerate 
the flow of money to consumers. But the banks must 
be taken into account because they cause changes in 
both the quantity of money in circulation and in the 
circuit time of money. No diagram is complete which 
ignores these changes. 

A similar defect in our diagram is the failure to make 
allowance for the action of the Government in changing 
the amount of money in circulation. Our system of res¬ 
ervoirs and pipes makes no provision for putting any 
more money into the stream or taking any money out. 
All the money flowing into the public treasury at the 
bottom of the page is represented as coming directly or 
indirectly from individual incomes. A complete diagram, 
however, would take account of the fact that govern¬ 
ments — not infrequently, as the world has recently ob¬ 
served to its sorrow—coin money or print money or other¬ 
wise supply the deficiencies in the government reservoirs, 
whenever money is flowing out through expense conduits 
faster than it is flowing in through taxation conduits. 

Factors that alter the Circuit Time of Money 

Our next question is, What factors retard or acceler¬ 
ate the flow of money from consumer back to consumer? 
This question would not concern us if money actually 
flowed through the channels of commerce as steadily as 
in our diagram. Here we have pictured all the pipes 
as unobstructed, free from leaks, and unvarying in size. 
If the circuit flow of money were such, day in and day 
out, that we could accurately represent it by means of 




THE CIRCUIT FLOW OF MONEY 


315 


such a simple and static picture, and if the flow of com¬ 
modities were equally steady, industry would be per¬ 
fectly stable. There would be no business cycles. But 
money never does flow through the arteries of trade as 
steadily as this. The rate of flow changes from time to 
time, often so slowly that the ordinary observer notices 
no change at all; sometimes so rapidly that nearly every¬ 
body is aware that something has happened, though 
there are few who know that it has happened to money, 
and nobody who knows exactly what it is that has hap¬ 
pened to money. Furthermore, variations in the rate of 
flow come more rapidly in some parts of the circuit than 
in others. These facts might be suggested by means of 
gate-valves in all the pipes, subject to the control of in¬ 
dividuals. Nothing but a motion picture, however, could 
show all these multifarious and kaleidoscopic changes. 
Our simple diagram can help us only in a general way to 
visualize the major movements. Not until we consider in 
what specific respects this diagram fails to depict what 
actually happens to money during the circuit are we 
likely fully to account for business instability. 

We may now enumerate some of the causes that ac¬ 
celerate and some of the causes that retard the circuit 
flow of money, with a view to suggesting profitable fields 
of research. In making this enumeration, we shall assume, 
first, that the total money in circulation remains the same 
and, second, that the effect of each cause is not offset by 
the operation of other causes. 

The circuit time of money is ordinarily decreased — 
that is to say, money moves around the circuit faster 
— under the following conditions: 

(1) When there is an increase in the total amount paid 
as wages; since wage-earners spend a larger proportion of 
their money for goods than do other groups of consumers. 7 



MONEY 


316 

(2) When taxes are decreased; since ordinarily money 
paid in taxes comes from consumers, but finds its way 
back slowly. 

(3) When there is a general belief that prices are about 
to rise; for then it appears that the quicker we spend our 
money, the more we get for it. Consequently, we carry 
smaller average cash balances, and spend a larger pro¬ 
portion of our money for commodities. 

(4) When there is general expectation of higher wages 
and higher profits; for at such times people spend money 
in consumption more freely. 

(5) When people save less than usual; since thrifty 
people usually have on hand some money, intended for 
savings banks, which they have not yet deposited. As 
the total savings of the country decrease, there is a corre¬ 
sponding decrease in the amount of money that is wait¬ 
ing to be invested. 

(6) When there is an increase in the amount of money 
borrowed, directly or indirectly, by consumers for use 
in consumption. 

(7) When a larger proportion of exchanges are made by 
means of bank checks; since consumers who pay their 
bills by check are likely to make most of their payments 
soon after most of their income is received, usually on the 
first few days of the month, and there is therefore less 
need for keeping money on hand. Whereas people who pay 
all their bills with currency usually distribute their pay¬ 
ments over longer periods of time; and, in order to do so, 
they carry larger average daily cash balances in propor¬ 
tion to their expenditures. 

(8) When pay-days come more frequently. As a rule, 
those who sell their services or lend their money collect 
their pay at fixed intervals of time; and, as a rule, what 
they receive on one pay-day they spend before the next 


THE CIRCUIT FLOW OF MONEY 


3i7 


pay-day. For the most part, wages that are received 
weekly are spent weekly; salaries that are received 
monthly are spent monthly; rents and dividends that are 
received quarterly are spent quarterly. All this in turn 
affects the receipts, and, therefore, the expenditures, of 
those who sell goods. Therefore, more frequent payments 
of wages, salaries, or dividends mean more rapid circu¬ 
lation of money from use in consumption back to use in 
consumption. 

(9) When goods pass through fewer hands on the way 
to the consumer; because of the elimination of some of 
the middlemen, for example, through the vertical inte¬ 
gration of industry. 

(10) When there is a decrease in the amount of money 
used to transfer real estate, stocks, bonds, etc.; since 
money, while in use for such purposes, is not used in 
consumption. 

(11) When the volume of undivided profits hitherto 
carried in the form of money is decreased. 

Under all these conditions, ordinarily, the circuit flow 
of money is accelerated: under the opposite conditions, 
it is retarded. 

The influence of most of these factors on the velocity 
of money has been considered by various writers, notably 
by Professor Irving Fisher, in The Purchasing Power of 
Money. But changes in these factors do not affect veloc¬ 
ity and circuit velocity in the same degree or even, in all 
cases, in the same direction. How important these differ¬ 
ences in degree and in direction may be, as factors in the 
price-level and in the state of business activity, we can¬ 
not tell without additional research. The last three, at 
least, of the conditions enumerated above appear to 
merit much further study. 8 

Throughout this enumeration we have assumed that 


318 


MONEY 


the total volume of money in circulation remains the 
same; whereas we are well aware of the fact that the 
volume does not remain exactly the same for any two 
days, and that, at times, the volume changes rapidly. 
To take this fact into account, however, we have only 
to change our conclusions slightly. Instead of saying, for 
example, that money flows faster when there is an in¬ 
crease in the total amount paid as wages, we must say 
‘‘when there is an increase in the proportion disbursed 
as wages of the total volume in circulation.” Similarly, 
we must make some of our other statements relative 
rather than absolute. 

We cannot dismiss so easily our assumption that the 
effect of each cause is not offset by other causes. We are 
not at all sure, for instance, of the exact effect of increased 
taxes on undivided profits, or on wages, or on stock 
exchange transactions. We do know that the nature of 
the taxes will make a difference, and that we are not 
prepared fully to explain business fluctuations, or thor¬ 
oughly to understand national monetary policies, until 
we have the aid of further research concerning the effects 
of various forms of taxation, under various conditions, on 
the circuit time of money. We need further research, as 
well, concerning fluctuations in the daily balances of 
individuals in pocket and in bank. Before we can deter¬ 
mine the influence of these fluctuations at different stages 
of the business cycle, we must correlate them with fluc¬ 
tuations in wages, prices, unemployment, and volume of 
trade. We must also find the correlations among other 
factors that influence the circuit flow of money. One 
conclusion, however, we can safely draw without further 
investigation: there is virtually no chance that these 
variations in the factors enumerated above would coun¬ 
terbalance. The circuit time of money is constantly 
changing. 


THE CIRCUIT FLOW OF MONEY 


319 


Conclusion 

In order to forecast business fluctuations, or even to 
explain those that have already occurred, we should know 
more than we now know about conditions that deter¬ 
mine fluctuations in the amount of money spent in con¬ 
sumption, including factors that alter the circuit time of 
money. How little we actually know is shown by the 
amazement among men generally over the way in which 
retail sales were sustained during the depression of 1921. 
Business as a whole was totally unprepared for the effec¬ 
tive consumers’ demand that continued after the slump 
in wholesale markets. Yet nothing magical happened. 
Every dollar spent by consumers came from somewhere, 
went somewhere, and left a record of some sort, nearly 
every time it was spent. These records, it is true, are not 
all that they should be. Measures of the flow of money 
through the various channels are not as comprehensive, 
or as accurate, or as detailed, or as readily available as 
we should make them. Yet even such records as we now 
have for 1921, if assembled, correlated, interpreted, and 
tested for error, by approved statistical methods, would 
undoubtedly go far toward explaining what appears to be 
a mysterious persistence of consumers’ demand. Even 
without such records for 1921, the consumers’ demand of 
that year might not have seemed at all mysterious, if simi¬ 
lar records of previous business cycles, similarly inter¬ 
preted, had been available and generally understood by 
leaders in commerce and finance. For it is probable that 
various forces that determined the volume of daily sales 
in 1921 operated in about the same way, in varying and 
measurable extents, as in previous periods of depression. 
It is possible, furthermore, that had we known, in the 
years following the War, as much as we might readily 


320 


MONEY 


have known about the circuit flow of money in previous 
years, in relation to the flow of consumers’ commodities, 
there would have been neither the extreme business ex¬ 
pansion of 1919 nor the disastrous contraction that fol¬ 
lowed. For the major causes of the expansion and the 
contraction were monetary and subject to human con¬ 
trol in a far greater degree than has hitherto been deemed 
possible. 9 


CHAPTER XIX 

THE ANNUAL PRODUCTION-CONSUMPTION 

EQUATION 

Business as a whole will be sustained, obviously, if there 
is an exact and continuous correspondence between the 
dollar-sales of consumers’ commodities and the output 
of these commodities measured in dollars at prevailing 
prices. In other words, business is sustained when people 
continue to use up commodities at the rate at which they 
are being prepared for use. But this unqualified truism 
does not take us far on our way to an explanation of busi¬ 
ness depressions. It goes without saying that in the course 
of time, except for such durable achievements as the 
pyramids and the Sphinx, men use up nearly all that they 
produce, and no more. If we take into account a suffi¬ 
cient number of years, it is true that “goods cannot be 
sold for consumption more rapidly than they are pro¬ 
duced .” 1 But time is the essence of our problem: for a 
time, goods can be sold for consumption more rapidly 
than they are produced. To keep business free from 
extreme fluctuations, production and consumption must 
balance within a sufficiently short period of time. 

What is a sufficiently short period? That is a question 
that deserves more extended consideration than it has 
ever had, or can have here. For our present purposes, we 
need not be more precise than to say that variations in 
the state of business activity will be slight if the desired 
balance occurs within twelve months. Nature is respon¬ 
sible for annual business cycles. Because of those seasonal 
fluctuations, both in production and consumption, from 


322 


MONEY 


which there is no escape, the cycle of the year is the short¬ 
est period of time within which we might reasonably hope 
to approach closely to a balance of output and effective 
demand. This balance we may call the annual consump¬ 
tion-production equation. For convenience, we may call 
it simply the annual equation. If we are to avoid busi¬ 
ness booms and depressions, variations from this bal¬ 
anced condition must be small, and these variations must 
soon offset each other. 

This is one reason why the Bonus Bill that was passed 
by the United States Congress in 1922, whether or not 
objectionable on other grounds, would have been bad for 
business at that time. Such a bill would mean an almost 
immediate increase of several hundred million dollars in 
bank deposits, provided the banks loaned money to the 
ex-service men as proposed in the bill. The greater part 
of this new money would be spent in consumption. This 
large and sudden increase of money, therefore, would take 
a large accumulation of finished goods off the markets. 
That would stimulate industry, lessen unemployment, 
and, after a while, increase the volume of production. So 
far, so good. But the immediate effect of a large increase 
in the money spent by consumers, with no simultaneous 
increase in the goods coming upon the markets, would be 
an increase in the price-level. In due time the full effect 
of the increased production would be felt in the markets; 
but at that time not all the “ bonus ” money originally 
spent would reappear as consumers’ demand, nor would 
there be any assurance of another increase of money in 
the hands of consumers to match the larger volume of 
goods. On the contrary, the bank loans would have to be 
paid, and the volume of money in circulation would thus 
be reduced. This, in all probability, would mean a falling 
off in sales, a drop in the price-level, and a new period of 


PRODUCTION-CONSUMPTION EQUATION 323 

depression and unemployment. The net effect of the 
Bonus Bill, therefore, would be bad for business, and bad 
for consumers generally, including the ex-service men 
themselves. 

Business instability is sometimes charged to the ac¬ 
count of the “joy-riders” who consume but do not pro¬ 
duce — those, for example, who adorn and amuse them¬ 
selves by spending inherited money, or gains from specu¬ 
lation in stocks or in land. Among these non-productive 
consumers are many of the “conspicuous wasters” who 
are excoriated in Thorstein Veblen’s Theory of the Lei¬ 
sure Class. But, however objectionable it may be to 
have any members of society appropriate for their per¬ 
sonal use far more than they contribute to society, we 
cannot for that reason hold them directly responsible 
for fluctuations in the world’s work. Their “joy-riding” 
cannot budge business as long as the amount they spend 
in consumption bears a constant relation to the other 
factors that determine the annual production-consump¬ 
tion equation. In this case, as in many others, changes 
are the center of interest. If non-producers spent much 
more than usual, they would tend to bid up prices and 
stimulate business: if they spent much less than usual, 
they would tend to lower prices and retard business. If 
most of them suddenly went to work, it would doubtless 
be good for them and for society; but it might not be im¬ 
mediately good for business, since there is no assurance 
that the products of their labor would be matched, soon 
enough and not too soon, with new consumers’ dollars. 
“Joy-riders” are partly to blame for low production as 
well as for some of the indiscriminate condemnation of 
men of wealth; but not for business fluctuations. Busi¬ 
ness can be sustained just as well with a low, as with a 
high, per capita production. 


324 


MONEY 


Overproduction 

It is with reference to the annual production-consump¬ 
tion equation that the term “overproduction” has its 
chief economic meaning. The misunderstanding of that 
term has been due largely to our failure to take into ac¬ 
count the monetary complications of the subject. 

The crudest of the misunderstandings of the term is 
still heard in denunciations of “heartless capitalists who 
speak glibly of overproduction when millions are in dire 
want.” Obviously, production of goods in general over 
and above the wants of mankind is at present impossible: 
there is no known limit to human desires. The term 
“overproduction” is seldom used in this sense either by 
business men or by economists. They are aware that, 
throughout the history of the race, capacity for consum¬ 
ing with satisfaction has kept far ahead of capacity for 
producing. This is true of things in the aggregate: it is 
not true of certain specific commodities. The United 
States alone could produce more shoes than all the 
people in the world could find any use for; but the United 
States, even at its maximum production capacity, which 
is far greater than anything yet achieved, could not more 
than satisfy all the wants even of its own people. That 
there could be no overproduction in this sense seems self- 
evident; yet it is exactly this misconception concerning 
the meaning of the term that often arouses indignation 
toward those who talk about overproduction. 

The traditional argument against the possibility of 
overproduction does not err in using the term with refer¬ 
ence to human desires. It makes an error which is more 
serious because more subtle. How absurd it is — so runs 
the argument — to imagine that the supply of goods can 
possibly be greater than the demand for goods! As a 


PRODUCTION-CONSUMPTION EQUATION 325 

matter of fact, demand and supply are one and the same 
thing. Is it not clear that, when I drive to town with a 
load of hay, the hay is my demand for goods and at the 
same time another man’s supply? I have added to de¬ 
mand and to supply exactly one load of hay: the balance 
between supply and demand remains precisely what it 
was before I drove into Haymarket Square. To be sure, 
I may sell the hay for money and then spend the money 
at the harness shop; but I must not allow the fundamen¬ 
tal nature of the transaction to be obscured by a mere 
medium of exchange. I have only to imagine a state 
of barter to see clearly that nothing really matters in 
this transaction except its two commodity ends. I dis¬ 
posed of a load of hay; I acquired a new harness; what the 
intermediary happened to be in this transaction is of no 
consequence. It is true that I may find a distressing lot 
of hay already in the market; there may have been a 
bumper crop. Harnesses, however, which I want to take 
home with me, may be comparatively scarce. In that 
case, there has been a relative overproduction of hay. 
But obviously not all goods can be relatively overproduced. 
Consequently, there can be no such thing as general over¬ 
production. This is the classical argument, typical of 
economic theory in overlooking the effects of money. 

It is precisely this traditional attitude toward the 
“mere medium of exchange” that has diverted attention 
from the only possible kind of general overproduction. 
That not all goods can be overproduced in relation to 
each other is an axiom. If, therefore, we follow the in¬ 
structions of some writers and consider nothing but 
goods, the idea of general overproduction seems absurd. 
If, on the other hand, we consider all that may happen 
to the medium of exchange, we see at once that there 
may readily be a general overproduction of goods in rela- 


326 


MONEY 


tion to the money which consumers offer in exchange for 
goods. That is to say, the annual equation may be upset. 
As a matter of fact, every business crisis is marked by 
this kind of overproduction. 

Enough Money to do Business with 

With this annual equation in mind as the basis of sus¬ 
tained production, we may ask the familiar question, 
How much money does business need? We know some of 
the answers that appear every day in newspapers, trade 
journals, and bank bulletins. We are told that “money 
must be responsive to the demands of trade”; that 
“currency must be sufficiently elastic to expand with the 
expansion of business”; that “we must have enough 
money to finance legitimate enterprises.” Such answers 
evade the real issues by employing only vague and unde¬ 
fined phrases. The question “how much?” is not an¬ 
swered in full until it is answered in quantitative terms. 
It is confusing to talk in a general way about the “mone¬ 
tary needs of business,” without reference to time, or 
markets, or prices . 2 

No monetary system can be sufficiently “elastic” and 
no volume of currency sufficiently large to satisfy every¬ 
body. Witness the current experience of Europe. In 
Russia, when the Government printing-presses made the 
world’s production record of two hundred trillions of 
rubles per month, there was general complaint of “a 
dearth of currency.” If we increased the money in the 
United States an hundred fold, many men would still 
complain that there was not enough money to do business 
with. That is because most men, naturally, answer the 
question only with reference to the condition of their own 
company, or their own industry, or their own section of 
the country; but the monetary needs of business as a 


PRODUCTION-CONSUMPTION EQUATION 327 

whole cannot be determined in this way. When employ¬ 
ment is at its height and employers are bidding up wages 
in order to take workmen away from each other, some 
men are sure to need more money in order to do business. 
If a country were to issue more money whenever a partic¬ 
ular company or industry or section felt hard pressed for 
funds, the country would be committed to an endless 
spiral of inflation. 

The annual equation is maintained, we have observed, 
when in the course of the year purchases by consumers as 
a whole take away the finished goods at the annual rate of 
production. The closeness of our approach to this exact 
balance is measured, not by the condition of any one 
locality or any one market, certainly not by the varying 
fortunes of producers of wheat, or wool, or copper, or any 
other one commodity, but by variations in the general 
price-level. Whenever the general price-level for a series 
of years shows a high degree of stability, we know that 
the combined transactions of all markets are close to the 
annual equation. When that happens, the country as a 
whole has enough money to do business with. 

The “Unbalanced State of Industry” Explanation 

When that does not happen, the resultant business de¬ 
pression is commonly attributed to an unbalanced state 
of industry. There is said to be a law of equilibrium which 
works out a natural balance between the occupations, a 
balance that must be sustained in order that the products 
or services of each group may be absorbed by all the other 
groups. The example is cited of the discrepancies between 
the prices of farm products and the prices of manufac¬ 
tured goods during 1921. Business stability, it is said, can 
be maintained only so long as the equilibrium in industry 
permits various groups of workers to be mutually sup- 


328 


MONEY 


porting. We are told, in short, that “the secret of pros¬ 
perity is in balanced industry.” 

This explanation of business depression does not carry 
us far beneath the surface of things. It leaves the deeper 
problems unanswered. Precisely what conditions must 
prevail if various groups of workers are to take each 
other’s products off the markets? Precisely what are the 
fundamentals of a balanced state of industry? Once in¬ 
dustry has become unbalanced, precisely what relation¬ 
ships are essential to the restoration of the balance? We 
do not answer these questions when we say that wages of 
printers must not be too high, that prices of farm prod¬ 
ucts must not be too low, that retail prices must not be 
too far above wholesale prices, and that transportation 
charges must be in right relations to other business costs. 
Nor do we answer these questions with any greater pre¬ 
cision when we say that “business must return to normal.” 

Evidently, sustained production does not require that 
the wages of certain groups of workers shall be in cer¬ 
tain fixed relation to the wages of other groups, since 
we have had approximately the same degree of business 
stability in different countries where widely different 
discrepancies have prevailed between the wages in certain 
occupations and the wages in others, and since various 
groups of workers have been mutually supporting on one 
scale of wages at one time and on quite another scale 
of wages at another time. A similar comparison between 
different countries makes it equally clear that business 
stability does not depend on a fixed relationship between 
transportation cost and other costs. There appears to be 
no “natural balance” between occupations. It is difficult 
to find any law of equilibrium that determines how much 
higher the incomes of physicians must be than the incomes 
of printers in order that business may go steadily on. Nor 


PRODUCTION-CONSUMPTION EQUATION 329 

Is there any evidence in economic history that there must 
be a certain relationship between the prices of farm prod¬ 
ucts and the prices of factory products before business 
can proceed on an even keel. Changes in any of these re¬ 
lationships are, no doubt, disturbing factors. Once these 
changes have been made, however, it is not necessary 
to restore previous conditions in order to restore business 
stability: on the contrary, history furnishes ample evi¬ 
dence that the old balance of industry can be set up on 
new relationships. Nor is there any guarantee that a re¬ 
turn to a former scale of incomes would mean a return to 
a former condition of business. There may be times when 
a return to former relationships should be urged for 
other reasons — in the interests of justice, perhaps, or 
social welfare, or increased production — but not as an 
essential of business stability. 

The belief is widespread that there are normal price- 
levels, normal wages, normal profits, normal transporta¬ 
tion costs, normal money rates, and so on, to which a 
country must return in time of depression before it can 
again enjoy the old conditions of balanced industry. 
This belief is based on error. At no time is it possible to 
find, in the statistical records of the past, a date when 
wages in general were “normal,” or the wages of carpen¬ 
ters, or the relation between the wages of carpenters and 
farm-hands. Equally futile would be the effort to find 
the date when profits in the rubber industry were “nor¬ 
mal,” or call-money rates, or the price of potatoes. All 
our indices of wholesale prices, production, bond valua¬ 
tions, interest rates, volume of business, and so forth, 
necessarily adopt a purely arbitrary “normal.” Cer¬ 
tainly, there is no known normal in any of these fields 
upon which business stability depends. When it takes 
ten bushels of corn to buy a pair of shoes that two years 


MONEY 


330 

before could be bought for five bushels of corn, fewer pairs 
of shoes are bought. Instability follows in the shoe busi¬ 
ness; there is no doubt about that. But this does not 
mean that two years ago the exchange values of corn 
and shoes were “normal” in any useful sense of the word. 
Nor does it mean that business stability requires a return 
to the price-relations of that particular date. 

Summary 

In conclusion, we may summarize three respects in 
which this analysis of the fundamental conditions of sus¬ 
tained production goes beyond the so-called law of sup¬ 
ply and demand, as it is usually expounded. The gen¬ 
eral statement that business is in equilibrium when the 
demand for goods equals the supply of goods does not 
definitely locate the causes of business booms and depres¬ 
sions, because it is not explicit concerning time, or mar¬ 
kets, or prices. In the first place, we pointed out that it is 
not enough for demand in dollars to reach the markets 
in sufficient volume to match the commodities produced: 
to insure sustained production, the commodities and the 
dollars to match them must reach the markets within 
the same twelve months. In the second place, we noted 
the fact (in previous chapters) that it is not enough to 
consider merely the total dollar-demand for commodities 
at a given time: to insure sustained production, this 
demand must be rightly distributed between producers’ 
and consumers’ markets. In the third place, we observed 
that, although there is usually a demand “at a price,” 
to insure sustained production, the demand must be at 
the current price. That is to say, in order to produce the 
desired equilibrium in business, demand in consumers’ 
markets, at prevailing prices, must balance supply within 
a sufficiently short time. The balance of supply and de- 


PRODUCTION-CONSUMPTION EQUATION 331 

mand which meets these three conditions is what we have 
called the annual equation. 

It follows that the relation of the amount of money 
spent in consumption to the commodities reaching con¬ 
sumers’ markets within the same period is the main 
factor in the ups and downs of business. But the main 
factor in determining the amount that actually will be 
spent in consumption is, not mental attitudes, but the 
amount that consumers have at their disposal. Conse¬ 
quently, in times of falling prices and industrial depres¬ 
sion, increases in the amount of money in the hands of 
consumers, up to the full amount necessary to move 
the accumulated goods at the current price-level, are 
economically advantageous: and, in times of industrial 
booms, increases in the amount of money in the hands of 
consumers up to, but not beyond, the full amount neces¬ 
sary to move the new goods at current prices, are eco¬ 
nomically advantageous. Out of all this, the conclusion 
follows that major fluctuations in business could be 
curbed if there could be sufficient control over fluctua¬ 
tions in the amount of money available for use in con¬ 
sumption. Some of the measures proposed for exercis¬ 
ing this control, we shall consider in the next chapter. 


CHAPTER XX 

COSTS AND PROFITS IN RELATION TO THE 

ANNUAL EQUATION 

The balance of supply and demand, which we have called 
the annual production-consumption equation, is upset, 
according to certain theories, 1 whenever, with profits 
rising, too small a proportion of the national income is 
paid out in wages, and too large a proportion is absorbed 
in other costs of production or invested in new capital 
facilities. According to the theory of R. E. May, in¬ 
creased output due to the progress of the arts can be 
taken from the markets only if the money income of the 
people is increased and the prices of commodities are de¬ 
creased. Crises are sure to come, therefore, if prices rise 
as the volume of production increases. As a means of 
prevention, Mr. May proposes a legal limitation of the 
rate of profits sufficient to bring about a decrease of 
prices commensurate with an increase of production. 2 
A. Aftalion considers the cause of crises as inherent in 
capitalistic methods of production. When business men 
are optimistic, they build new factories and order new 
equipment. For a while all seems to be going well. Pres¬ 
ently, however, the new capital facilities bring about 
an overstocked market, prices fall, and business is de¬ 
pressed. The Aftalion special contribution to the theory 
of business cycles is the idea that the break in prices' is 
due to the fact that general overproduction diminishes 
the social use-values of commodities as a whole; but, ac¬ 
cording to his theory, undue expansion of the means of 
production is a basic cause of the trouble. 3 According to 


COSTS AND PROFITS 


333 


M. Bouniatian, rising prices and rising profits tend to 
concentrate purchasing power in the hands of a compar¬ 
atively few people. Their desire to consume does not keep 
pace with the growth of their income. At the same time, 
rising profits provide added incentives to further invest¬ 
ment in the means of production. For these reasons, con¬ 
sumption does not keep up with the accumulation of 
capital and the production facilities in which the capital 
is invested. Presently, therefore, prices must fall and 
bring an end to prosperity. 4 A. Spiethoff finds the cause 
of crises in an ill-balanced development of industrial 
equipment and complementary goods. Rising profits in¬ 
duce men to invest heavily in new means of production. 
Presently, however, the slowing down of the demand for 
new capital goods and stringency in the money market 
combine to stop the upward movement of business. 5 
Jean Lescure also ascribes business cycles to irregular 
activity in the development of capital facilities. This 
irregularity, in his view, is due to changes in the expected 
rate of profits. 6 However helpful these theories may be, 
they seem to us to fall short of explaining exactly what 
happens to consumers’ demand, and the proposed rem¬ 
edies seem to us insufficient, because there is no adequate 
analysis of the relation of the circuit flow of money to the 
annual consumption-production equation. 

Two Popular Current Theories 

Among the most popular exponents of similar theories 
at the present time are the English economists, C. H. 
Douglas and J. A. Hobson. Both have an enthusiastic 
following. We agree with these writers and with their 
numerous disciples in attributing cyclical business de¬ 
pressions to the failure of money spent in consumption to 
take away commodities as they reach consumers’ mark- 


334 


MONEY 


ets. Mr. Hobson is right in part when he contends “that 
the proper provision against trade depressions and un¬ 
employment lies in strengthening the consuming powers 
of the community, so that effective demand for consum¬ 
able goods may keep full pace with every increased pro¬ 
ductivity that arises from improvements in the arts of 
industry.” 7 By means of a different analysis, we have 
arrived at the same conclusion, though we feel obliged 
to add that the need is not always for a strengthening of 
consuming powers. Sometimes consumers’ demand goes 
forward at such a rapid pace that it is riding to an inevi¬ 
table fall. We agree, however, that during the past gener¬ 
ation the volume of production and our standards of liv¬ 
ing have been lower than they might have been, partly 
because the time comes periodically when total produc¬ 
tion cannot be disposed of at prices that warrant pro¬ 
ducers to continue operations at the prevailing scale. 
But both the Douglas and the Hobson explanations of 
the cause of this phenomenon are to us unconvincing. 

The “ Discrepancy ” between Wages and Market Prices 

Both writers raise the question whether production is 
now financed in such a way as to place in the hands of 
consumers enough money to take away the current out¬ 
put of commodities at prevailing prices. Production is 
usually carried on for profit and usually profit is realized. 
This means that commodities are offered in the markets 
for more dollars than are paid to all those workers who 
aided in putting them on the markets. Consequently, as 
long as profits are made, the money disbursed to cover 
wages and other costs will not be sufficient to buy the 
commodities at prevailing prices. “In consequence of 
this,” says C. H. Douglas, “the book-value of the world’s 
production is continuously growing more and more in ex- 


COSTS AND PROFITS 


335 


cess of the capacity to absorb and liquidate it, and every 
transaction between buyer and seller increases this dis¬ 
crepancy so long as the exchange takes place at a value 
in excess of the total wages, etc., which go to the various 
conversions of the product, with the result that a contin¬ 
uous rise in the cost of living absolutely must take place, 
apart and above that represented by currency inflation, 
palliated by intrinsically more efficient productive 
methods .” 8 

Obviously, there is something the matter with this 
reasoning; for the result which the author declares must 
come from the specified causes has not always come. On 
the contrary, the cost of living — the cost in human ef¬ 
fort — is much less than formerly. During periods of 
rising prices, it is true, wages lag behind the cost of living: 
during periods of falling prices, wages fall more slowly 
than prices. But considering the past century of produc¬ 
tion at a profit, during which prices have risen and fallen, 
we find that the real wages of a day’s labor have in¬ 
creased . 9 To what has this gain been due? Partly, no 
doubt, to the fact that all adverse influences have been 
not merely “palliated,” but more than offset, by increas¬ 
ingly efficient methods of production. 

Nevertheless, the question under what conditions it is 
possible to produce commodities at a profit, and at the 
same time keep enough money flowing into consumers’ 
hands to buy the commodities at current prices, cuts 
deeply into the major problems of business. The asser¬ 
tion of Major Douglas, that profit “represents deprecia¬ 
tion, obsolescence, scrapped material, etc., all of which 
are charged to the consumer instead of being a charge 
against the value of the product,” 10 seems to be beside 
the point. Necessarily, they are charged to the consumer; 
they would be so charged under socialism or communism; 



336 


MONEY 


and they always will be so charged, since we are not likely 
to invent machines that do not wear out or machines that 
cannot be supplanted by better ones. The balance be¬ 
tween the selling price and the cost is the profit, no matter 
what enters into the cost; and the question whether a 
given enterprise puts enough purchasing power into cir¬ 
culation to take its products off the market at the going 
price does not depend on what the profit “ represents.” 
It does depend in part on what is done with the profits 
and when it is done. 

The Douglas Theory 

We are not sure that we have obtained a clear idea of 
the Douglas theory, either from the writings of Major 
Douglas or from the various followers who have under¬ 
taken to interpret his writings . 11 The core of that theory, 
as we understand it, is that there is no possibility of sell¬ 
ing all the commodities that could be produced because 
our present monetary system does not bring into existence 
enough income to buy them. According to this theory, 
not only do we fall far, far short of our potential produc¬ 
tion because of lack of consumers’ purchasing power, but, 
for the same reason, it is economically impossible to mar¬ 
ket all that is actually produced. It is impossible, we are 
told, because only a small part of the money that goes 
into costs of production, and which, therefore, in the long 
run must be included in retail prices, gets into the hands 
of consumers. And the assumption is at least implied 
that consumers never have any other way of obtaining 
enough money to buy the goods at these prices. 

Price, says Major Douglas (in the least obscure of his 
explanations), cannot nominally be less than cost plus 
profit, but cost includes all that is spent in production. 
Therefore, cost includes not only all that is spent in con- 


COSTS AND PROFITS 


337 


sumption (out of wages, salaries, and dividends), but 
also all that is spent in production, which also represents 
previous consumption. Since cost includes all this, a por¬ 
tion of the cost has already been paid by the recipients 
of wages, salaries, and dividends. These recipients are 
the community. Therefore, all the purchasing power 
that the community receives is the surplus wages and 
salaries and dividends that are available after all sub¬ 
sistence expenditure and costs of materials consumed in 
the process of production have been paid. Surplus pro¬ 
duction, however, includes all this expenditure in costs. 
All of which leads Major Douglas to conclude that “the 
only effective demand of the consumer is a few per cent of 
the price-value of commodities, and is cash credit. The 
remainder of the Home effective demand is loan credit, 
which is controlled by the banker, the financier, and the 
industrialist, in the interest of production with a financial 
objective, not in the interest of the ultimate consumer.” 12 

It is not surprising that this theory has been eagerly 
accepted by large numbers of people, because no explan¬ 
ation of our economic difficulties is more popular than 
that which charges them all up indiscriminately to the 
administration of bank credit. It is not clear, however, 
that Major Douglas or any of his followers has offered an 
analysis of cost and profit that justifies their conclusions. 

The most obvious comment on the Douglas argument 
is that it is inconsistent with the facts; for the results 
which we are told must follow from the assumed causes 
do not follow. If the consumer really had no other effec¬ 
tive demand than a few per cent of the price-value of the 
commodities produced, the industrial order would not 
experience merely those recurrent setbacks which we have 
pictured in Figure I: virtually all the processes of pro¬ 
duction and distribution would cease. Not only would a 


338 


MONEY 


large proportion of the population suffer from unemploy¬ 
ment, but a still larger proportion would die of starvation. 
The fact that, decade after decade, consumers somehow 
manage to buy virtually all the goods that are produced 
at prices which cover both costs and profits discredits the 
conclusion that the consumers’ only effective demand is 
but a few per cent of the price-value of commodities. 

How does the Douglas argument arrive at this false 
conclusion? Precisely why is it, according to this argu¬ 
ment, that most of the money involved in costs of pro¬ 
duction and accumulated in the retail price never reaches 
consumers’ hands? For two reasons, we are told: first, 
because such costs as those due to overhead charges, 
factory account, and raw materials are met from the 
proceeds of bank loans, and these loans are made, not in 
order that consumers may buy commodities, but in order 
that the commodities may be produced. This is no reason 
at all. Due consideration of the circuit flow of money 
will show that wages paid to the machinists who make a* 
printing-press and to the workers who supply the pulp 
for a paper mill flow into consumers’ markets just as 
readily as wages paid to the typesetters in the composing- 
room of a newspaper. And they flow just as readily from 
bank loans as from any other source. All these “costs” 
are available to buy finished products. 

As a second alleged reason why only a small part of the 
costs of production are available to buy the products, the 
Douglas argument contends that most of the wages, 
salaries, and dividends paid in connection with bringing a 
given consignment of consumables to market have been 
spent long before that consignment reaches the market. 
That is true. Only a trifling part of the wages that have 
been paid to all those who helped to produce this morn¬ 
ing’s newspaper are used to buy copies of the paper. But 


COSTS AND PROFITS 


339 


this, as we have said in our discussion of “ Money Ad¬ 
vanced in Production,” is the ordinary course of business. 
This is precisely how money flows through the myriad, 
intricate channels of trade. Nevertheless, as long as car¬ 
penters, clerks, and innumerable other workers continue 
to spend enough of their current income at the news¬ 
stands, the product of the printing-presses is bought. 
That is why there are times when the newspapers and all 
the other products of a country are bought by consumers, 
year after year, at just about the rate of production; and 
at such times all the forces are in operation which, ac¬ 
cording to the Douglas argument, render impossible that 
which actually happens. 

The Hobson argument does not hold that so much 
money goes to pay these “costs” of production that there 
is not enough money in existence to buy the finished prod¬ 
ucts at current prices. It holds that there is enough 
money, if rightly distributed, to buy all products at cur¬ 
rent prices; but that, whenever prices and profits rise, 
there is a lag in wages, with the result that too large a 
proportion of the money in existence goes to saving, in 
the form of new capital facilities, and too small a propor¬ 
tion to spending. Now, both these theories involve the 
tacit assumption that money is employed either for pro¬ 
duction or for consumption, and that once it is used for 
either purpose, we have no further interest in it. W hat 
subsequently becomes of the money? Once used for any 
purpose, how long does it take to reach consumers 
markets? Only when we pursue these questions do we 
find the flaws in the arguments. 

The Hobson Theory 

It is the failure to take due account of these questions 
that seems to us to invalidate the central argument of 


340 


MONEY 


Mr. Hobson’s The Economics of Unemployment. To ac¬ 
count for trade depressions, says Mr. Hobson, “there is 
only one sort of maladjustment of economic forces ade¬ 
quate in nature and magnitude . . . viz., a normal tend¬ 
ency to apply to the production of capital-goods a pro¬ 
portion of the aggregate productive power that exceeds 
the proportion needed, in accordance with existing arts 
of industry, to supply the consumptive-goods which are 
purchased and consumed. In other words, if there exists 
a normal tendency to try to save and apply to capital 
purposes an excessive proportion of the general income, 
we have a valid explanation of the actual phenomena of 
fluctuations and depressions.” 13 

The theory is further expounded in the following pas¬ 
sage from The Economics of Unemployment : 14 

“I trace this failure, not to any lack of the monetary 
power to purchase all the commodities that could be 
produced, but to the refusal of those in possession of this 
power of purchase to apply enough of it in buying con¬ 
sumables, because they prefer to apply it to buying 
non-consumables, in other words, to buying capital- 
goods.” 

Let us consider this theory in connection with the up¬ 
ward swing of a business cycle. As prices rise in consum¬ 
ers’ markets, profits increase faster than wages. Those 
who receive the profits invest a larger proportion of their 
incomes than formerly in producers’ markets: that is to 
say, they increase their savings faster than their expen¬ 
ditures, and their savings take the form of new capital 
facilities. For this reason a smaller proportion than for¬ 
merly of wages, rents, interest, and dividends is spent at 
once in consumers’ markets. Therefore, we are told, the 
commodities that are produced cannot be sold at pre- 


COSTS AND PROFITS 


341 


vailing prices, since these prices include increased profits 
which, having been diverted to the creation of new capi¬ 
tal facilities, are not available for the purchase of con¬ 
sumers’ commodities. Here we have the argument re¬ 
duced to lowest terms. 

Our first observation concerning it is that it is incon¬ 
sistent with business experience. In time of war, for ex¬ 
ample, an extraordinary proportion of the national in¬ 
come is used for the construction of shipyards, munition 
factories, and other means of production. Presently these 
facilities lie idle, because they have been increased in ex¬ 
cess of the demand for what they can produce. They 
correspond in all essentials to the forms of ‘ ‘ over-saving ” 
in time of peace to which Mr. Hobson ascribes the de¬ 
ficiency in consumers’ purchasing power. But evidently 
the diversion of an unusual proportion of the national 
income in the United States to shipyards and munition 
factories during 1917 and 1918 did not cause a falling-off 
in consumers’ demand: on the contrary, the demand in¬ 
creased by leaps and bounds, and continued to increase 
for nearly two years after the close of the War. Neither 
the fact that an increased proportion of our income was 
utilized for new capital goods, nor the fact that these 
facilities proved to be in excess of our needs, is sufficient 
to account for the eventual slump in retail markets. 

Profits and the Circuit Flow of Money 

The Hobson theory does not take fully into account the 
circuit flow of money. As a rule, money flows from one 
use in consumption back to another use in consumption: 
consequently, the mere fact that profits rise faster than 
wages does not prevent any money from reaching con¬ 
sumers’ markets. Perhaps we can make this point clear 
by tracing the flow of a certain block of profits. Let us 


342 


MONEY 


suppose that they are invested in a new candy factory. 
For our present purpose, it does not matter whether 
these profits are realized on the sale of candy and put 
back into the business by the candy manufacturers, or 
distributed as dividends by various corporations and sub¬ 
sequently borrowed by the candy manufacturers. In 
either case, most of these profits go to wage-earners — to 
the workers who supply the bricks, lumber, and cement 
as well as to the bricklayers, carpenters, and masons who 
erect the building. Thus, most of the money reaches 
people who quickly spend in consumption nearly all that 
they receive. Some of the profits, however, which are 
used to build this new factory, are not at once paid out as 
wages, but become the profits of dealers and contractors. 
Even if we assume that they, themselves, spend none of 
these profits, but invest all in new capital goods — in 
motor trucks, for example — still most of these profits 
are paid as wages to those workers, all the way from the 
mines to the salesrooms, who had a part in making and 
distributing the trucks. 

If we continue in this way to trace the course of rne 
profits with which we started, we find that the fact that 
they were first used in producers’ markets does not pre¬ 
vent a single dollar from being spent in consumers’ 
markets. Money does not go out of circulation merely 
because, after it is distributed as profits, the profits are 
used to create new means of production. And if money 
continues in circulation, it is all spent presently in con¬ 
sumption, and flows thence to other uses. Neither the 
Douglas theory nor the Hobson theory follows the money 
far enough. Both theories seem at times to involve the 
assumption that money, once it is used in certain parts 
of the productive processes, is as effectively disposed of as 
fuel. They do not distinguish carefully enough between 


COSTS AND PROFITS 


343 

the saws which are used up, once and for all, in a lumber 
mill, and the money which, like the falling water that 
runs the saws, merely passes through the mill on its way 
to do other economic work. It is true that on the way 
from consumer back to consumer, money sometimes 
goes out of existence: it is used to pay bank loans. The 
importance of this fact we have emphasized above, es¬ 
pecially in Chapters XII and XIII. But money does not 
disappear from circulation for any of the reasons which 
these theories hit upon as the causes of business depres¬ 
sions. There is nothing either in the fact that cost in¬ 
cludes all expenditure on product, or in the diversion of 
money to new capital facilities, which in itself prevents 
enough money from flowing into consumers’ markets to 
take away current production at current prices. Conse¬ 
quently, both the Douglas theory and the Hobson theory 
fail to explain cyclical depressions or to suggest convinc¬ 
ing remedies. 

Mr. Hobson’s Constructive Proposals 

The shortcomings of the theory appear again in one of 
Mr. Hobson’s constructive proposals. In order to reduce 
the wage-lag and thus reduce the volume of profits that 
are used to augment our productive resources, he says 
that the Government should take a larger share of the 
profits and build electric superstations, for example, or a 
Channel Tunnel. 15 Overlooking the more obvious ob¬ 
jections to this plan, including the probability that in¬ 
creased Government expenditures would tend to decrease 
total production, we may consider the bearing of his pro¬ 
posal on his main thesis. What difference would it make 
in consumers’ markets whether a given amount of money 
was disbursed as profits and invested by individuals in 
factories, or collected as taxes and used by the Govern- 


344 


MONEY 


ment to build a tunnel? Would it necessarily make any 
difference in either the supply or the demand side of the 
markets which way the money was employed? During 
the period of construction, neither the tunnel nor the 
factory would make any addition to the goods side of the 
annual production-consumption equation. Whether there 
was any addition after construction was completed would 
depend on the decisions made at that time. Factories do 
not produce goods or tunnels render services merely be¬ 
cause they are built. Unless the prospects of demand 
seem satisfactory at the time production schedules are 
laid out, the existing capital facilities are not used to ca¬ 
pacity. 

Nor would it necessarily make any difference in con¬ 
sumers’ demand — in the dollar side of the equation — 
whether the money went into a privately owned factory 
or into a publicly owned tunnel. In neither case is there 
anything to prevent all the money from flowing into con¬ 
sumers’ markets. Whether it would make any difference 
in those markets depends on whether it would make any 
difference in the circuit time of money. Suppose we as¬ 
sume — an assumption that might well be contrary to 
fact — that the Government so employed the money, 
the first time it was used, that a larger proportion went 
into wages, and a smaller proportion into profits, than 
would be the case if the money were invested by private 
citizens. Even so, there is no certainty that the money 
would be spent any sooner to take away finished products. 
On the contrary, the Government might take so much 
time in collecting the taxes, in discussing the proposed 
expenditures, and in getting the work under way, that 
the money in question might reach consumers quicker 
through private channels, even though some of it had 
figured as profits several times on its way to consumers. 



COSTS AND PROFITS 


345 


That is to say, the anticipated speeding-up of the circuit 
flow of money, due to an increase in the proportion of 
the currency and credit in circulation which is paid as 
wages, might not be realized because of the slowness 
with which the taxes reached pay envelopes and were 
thus returned to consumers. 16 

As another means of reducing the margin between 
wages and profits, Mr. Hobson maintains that as prices 
rise employers should increase wages more rapidly. 17 By 
what practical means are we to bring this about? The 
author does not say. Shall we jump to the naive conclu¬ 
sion that, since the problem arises out of wrong relation¬ 
ships among wages, profits, and prices, the solution is 
Government regulation of wages, profits, and prices? Un¬ 
fortunately, the way out is not so simple. Government 
regulation, as we have shown in our chapter on “ Money 
and Prices,” would be slow, erratic, costly, bungling, and 
unjust. Could we not, then, accomplish our purpose 
merely by requiring that wages shall increase as rapidly 
as profits? Not under the conditions which have pre¬ 
vailed in every industrial order that has worked; for 
there is no possibility of telling, at the time wages are 
paid, what the profits are going to be. Could we not 
at least require that all employers regulate their wage 
schedules in accordance with an index of the cost of 
living? Here, again, we meet the injustice and ineffec¬ 
tiveness of regulations that ignore the varying fortunes 
of business concerns. Rising prices affect different con¬ 
cerns, at different times, in infinitely different ways. 
The proposed regulation would ruin some producers and 
but slightly reduce the profits of others. As long as exist¬ 
ing conditions permit sharp fluctuations in the price- 
level, it is impossible to prevent business depressions by 
means of Government regulation. 


346 


MONEY 


Both the Douglas theory and the Hobson theory, al¬ 
though neither writer endorses the theory of the other, 18 
have been widely and warmly accepted. Naturally so; 
for many people take kindly to the idea that smaller 
profits and higher wages would cure our industrial ail¬ 
ments. Workers, no less than employers, are inclined to 
protect from the pains of rigorous criticism all arguments 
that lead to welcome conclusions. But when we examine 
these theories in the light of our analysis of monetary 
circulation — inadequate though it is -— we are forced 
to the conclusion that, however palatable the remedies 
might be, they would not reach the causes of the disease. 
These theories do not lay hold of the factors that bring 
about recurrent deficiencies in consumers’ purchasing 
power. Neither theory accounts for the deficiency at 
certain times or for the adequacy at other times. A 
study of our diagram of the circuit flow of money should 
make it evident that the factors which, according to 
these theories, are chiefly responsible for our troubles 
might remain, and we might still have a flow of money 
into consumers’ markets sufficient to keep the goods 
flowing out at the current price-level: the annual pro¬ 
duction-consumption equation might still be maintained. 
The dominant economic factor in the spiral that culmi¬ 
nates in a shortage of purchases in retail markets is a 
fluctuating price-level; but neither of these theories ac¬ 
counts for this factor or shows how to control it. 

Profits and the Annual Equation 

If consumers are to obtain enough money to buy the 
entire current output of commodities, without a change 
in the price-level, producers as a whole, including farmers, 
must in some way disburse enough money to equal 
the sale price of the commodities, and disburse it soon 


COSTS AND PROFITS 


347 


enough. To do this they must disburse more money 
every year; for, to maintain the existing standard of liv¬ 
ing for a growing population, there must be increased 
production. But, if there is to be increased production 
without a change in the price-level, there must be an in¬ 
creased volume of currency and credit. Theoretically, it 
is true, a speeding-up of the circuit flow of money might 
maintain the price-level just as well as an increased vol¬ 
ume of money. Actually, changes in the circuit time of 
money do not suffice for this purpose. Consequently, in 
order that the additional commodities may be purchased 
by consumers without a change in the price-level, there is 
the necessity, year after year, of adding to the volume of 
money. Nearly all this additional money must be pro¬ 
vided, as business is now financed, by joint action of 
banks and producers. 

Even if producers borrow money and make additional 
payments in wages, dividends, and so forth, equal to the 
sale price of their increased product, a part of this addi¬ 
tional money will not reach consumers’ markets as soon 
as the product. There may be, in consequence, an accu¬ 
mulation of unsold stocks until the new money has caught 
up with the new stocks; for those who make commodities 
and sell them at a profit do not disburse their profits at 
the time the commodities are produced, but only after 
they have been sold. Consequently, when enterprises be¬ 
gin to increase production, although at first they add 
dollar-demand to the markets and no commodities, 
later on they do not pay out an amount sufficient to cover 
the sale price of their products. If they continue, how¬ 
ever, to pay out all the profits they receive by virtue of 
increased production, the time will come when the daily 
purchases will take away the increased output at current 
prices. This will be true only if there are no changes, 


MONEY 


348 

meanwhile, in the spending habits of the community suf¬ 
ficient to change the circuit time of money. If the indi¬ 
vidual consumers keep on hand larger cash balances, or 
spend a larger proportion of their incomes on services, 
the disbursing of all profits will not prevent a drop in the 
price-level. 

The point we are here making is that, contrary to the 
assertions of several present-day writers, there is nothing 
in the production of commodities for sale at a profit 
which, in and of itself, prevents consumers from obtain¬ 
ing enough money to buy the commodities at the cur¬ 
rent price-level. This is true even when the total volume 
of commodities and the total volume of services are in¬ 
creasing. It is true even when profits increase at a faster 
rate than wages. It is equally true, though a larger pro¬ 
portion than usual of the profits is invested in new capital 
equipment. 

On the other hand, no matter how readily loans may be 
obtained, our present systems of production and finance 
give no assurance that producers of commodities will 
borrow and place in circulation, as wages, interest, divi¬ 
dends, and so forth, the right amount of money, at the 
right time, to take their commodities off the markets at 
current prices. In other words, there is no necessary cor¬ 
relation between the amount of money which is actually 
borrowed to finance increased production within a given 
year and the amount of money which consumers must 
have in order to buy the additional commodities at the 
prevailing price-level. 19 

Before we can account fully for the effect of profits on 
the flow of money to consumers and the state of business 
activity, we must delve deeper into the subject than any 
of the explanations of business cycles that we have ex¬ 
amined and deeper than we have gone in this chapter. 


COSTS AND PROFITS 


349 


In Costs and Profits , which is Poliak Publication Number 
Three, some progress is made in the right direction. But 
there is much more work to be done. The Poliak Founda¬ 
tion hopes to undertake some of that work. 

By way of summary, we may now enumerate some of 
the phases in the upward swing of business cycles that 
culminate in a deficiency of consumers’ purchasing 
power: 

In a period of depression, prices, profits, wages and the 
cost of doing business are low, and bank reserves are 
high. At the close of the period, stocks are low be¬ 
cause dealers have been ordering only to cover day to 
day needs. The time comes, however, when the pur¬ 
chase of certain kinds of commodities cannot longer be 
postponed. About this time, dealers believe that prices 
have reached bottom. They increase their orders, cau¬ 
tiously at first. Manufacturers increase their output. 
There is a growth in the physical volume of trade. 

At first, when the volume of production increases, wages 
reach consumers’ markets as increased effective demand 
in advance of the increased supply of commodities. 20 
This stimulates a rise in prices which would otherwise 
come more slowly. 

The rise in prices accelerates the buying movement. 
Prices rise faster than wages. 

For a while, partly because of increased bank loans, 
partly because of delays in delivery of commodities to 
markets, partly because of the speculative withholding 
of commodities, 21 enough money flows into consumers’ 
hands to buy, at the higher price-level, enough com¬ 
modities to sustain the orders of retail merchants. 
Profits, however, rise faster than wages, and profits are 


350 


MONEY 


not distributed until after the commodities are sold 
upon which the profits are realized. 

The time comes when the markets feel the full effects of 
the increased supply of commodities, but when the 
increased volume of purchasing power, due to the ex¬ 
pansion of bank loans, is not sufficient to keep dollar- 
demand up with supply. 

Then, there must be further expansion of bank loans or a 
fall in the price-level. 

But, on account of reserve requirements, bank loans can¬ 
not expand indefinitely at a sufficiently rapid rate. 
Furthermore, the eagerness to expand operations is 
curbed by the increased costs of doing business: wages, 
salaries, rent, and interest, which lagged behind profits, 
begin to catch up. 

As soon as the banks, by raising the bank rates, indicate 
that the expansion of bank credit is approaching an 
end, speculators unload stocks, dealers diminish orders, 
and producers curtail production. 

Prices stop rising. 

As soon as prices stop rising, they begin to fall, since much 
of the business that has sprung up during the rise in 
prices depends for its existence upon a continued rise 
in prices. 

Once prices begin to fall, many influences operate to¬ 
gether to continue the movement, and a period of busi¬ 
ness depression ensues. 

In this whole movement, the central factor is a chang¬ 
ing volume of money flowing through various channels 
in such a way as to cause, or at least to make possible, 
changes in the annual equation and the price-level. 


CHAPTER XXI 

CONCLUSIONS 

Our Economic Problems are chiefly Monetary 

To the question raised in our opening pages, we have 
found but one answer: there cannot be intrinsically a 
more significant thing in the present economy of society 
than money. To insist that money is a superficial phenom¬ 
enon is to overlook the central clue to economic myster¬ 
ies. We could as profitably study telephony on the as¬ 
sumption that the electric current is of little account. Ev¬ 
idently, some of our historic economic structures, built as 
they are upon the idea that “ money belongs to the higher 
complications of the subject,” 1 should be reconstructed 
around money as a framework. Again and again in our 
discussions, first from one point of view and then from an¬ 
other, we have been forced to that conclusion. So long as 
we have thought only of goods, and tried to conceive of 
modern trade as merely refined barter, we have arrived at 
no explanation of what goes on in business, no explana¬ 
tion of what periodically fails to go on in business. And 
so long as we have thought of money as a fund, we have 
made no progress. When, however, we have attempted to 
trace the flow of money from use in consumption to an¬ 
other use in consumption, and to measure the forces that 
retard or accelerate this flow, as well as the forces that 
change the volume, we have seen new light on the prob¬ 
lem. 

In this light, what shall we say of current doctrines con¬ 
cerning thrift, foreign trade, “easy money,” tariffs, bonus 


352 


MONEY 


payments, farm loans, extra dividends, excess profits 
taxes, European debts, interest rates, reserve ratios, price 
regulation? Further discussion of all these matters would 
take us beyond our present purpose. But is it not already 
clear that current controversy concerning these subjects 
often overlooks the main issue? Is it not evident that in 
each case no policy is wholly satisfactory unless it serves 
to maintain the price-level and the production-consump¬ 
tion equation, by helping to equalize the flow of money 
into consumers’ hands and the flow of commodities into 
consumers’ markets? 

Consider, for example, the meaning of thrift. We have 
come, as a nation, to look upon thrift as a cardinal virtue, 
and to think of thrift mainly as saving money instead of 
spending it. That has long been the teaching of most of 
our public schools. But is this kind of thrift always a na¬ 
tional blessing? There seems to be some confusion on this 
point, for not long ago we had at the same time a National 
Buyers’ Week and a National Thrift Campaign. The an¬ 
swer to our question is to be found neither in our tradi¬ 
tional teaching concerning thrift, nor in the viewpoint of 
those who have goods to sell. Whether the people of any 
country should save more money or spend more money 
depends on the state of business. As the price-level be¬ 
gins to fall, they should spend more: as the price-level be¬ 
gins to rise, they should spend less. Unfortunately, they 
do the opposite: as prices rise, buyers rush in; as prices 
fall, they hold aloof. 2 Thus, they always make matters 
worse. Had the people of the United States, as a whole, 
spent more money during 1921, they would have saved 
more wealth. Had they taken due account of the rela¬ 
tion of the circuit flow of money to economic welfare they 
might have revised their ideas, not only concerning thrift, 
but also concerning many other economic doctrines. 


CONCLUSIONS 


353 


Economic Problems are not chiefly Moral Problems 

Contrary to the contentions of many reformers, the 
root of economic problems is not moral. We can imagine a 
ship lost at sea, without officers or crew, a ship with me¬ 
chanically perfect engines, ample supplies of fuel and oil, 
plenty of able-bodied passengers, with the best will in the 
world toward each other, and of one mind concerning the 
port they wish to reach. Yet we know that the machin¬ 
ery and good will would leave the passengers helpless, un¬ 
less they knew how to run the ship. So it is in the world of 
business. Good will toward men is not enough. Often we 
are told that the root of our industrial troubles is greed, 
that all would be well with the world if captains of indus¬ 
try were inspired by the love of mankind; but when it 
comes to telling us exactly what to do in the concrete situ¬ 
ations of everyday business, moralists are often silent, or 
vague, or absurd. No matter how earnestly men may de¬ 
sire to do unto others as they would have others do unto 
them, they cannot follow that golden rule when, in a 
given complicated situation, they are at a loss to know 
what they really would like to have others do unto them. 
The fact is that even in those unusual cases in which man¬ 
agers of industry have any real choice, they are often 
puzzled to know whether public welfare requires them to 
shut down factories or to continue producing goods that 
cannot be sold, to take the risks involved in borrowing 
money or to discharge workers. Those who are chiefly re¬ 
sponsible for our commercial and financial policies do not 
bring down upon us the evils of inflation and deflation 
through design, but because they do not yet understand 
these movements, or know exactly what to do to prevent 
them. 


354 


MONEY, 


Means of mitigating Fluctuations in the Price-Level 

All our discussions concerning the characteristics of 
money have led us to the conclusion that the most sig¬ 
nificant — the one which does more than all others to 
obstruct economic progress — is its instability of value. 
Professor Fisher has proposed to stabilize the purchasing 
power of money by changing the weight of gold behind 
the dollar. 3 As the price-level goes up, he would increase 
the weight of the dollar, thus decreasing the volume of 
currency in circulation, thus tending to lower the price- 
level. As the price-level goes down, he would decrease the 
weight of the dollar, thus making possible an increase in 
the volume of currency in circulation, thus tending to 
raise the price-level. This plan gives rise to various ques¬ 
tions. One of them we mentioned above. Under existing 
conditions, our markets periodically become so glutted 
that a change in prices is the quickest, available way out 
of what might otherwise become a deadlock between 
producers and consumers. The extent to which this 
glutted condition is itself due to changing price-levels, 
we do not know. The best plan we can devise at present 
must be tentative and flexible. 

There is the further question how long it would take 
for a given change in the weight of the dollar to bring its 
purchasing power back to the desired level. All discussion 
of this question is necessarily speculative: nothing but 
experience could show exactly how long the ‘dag” would 
be between the corrective action and the desired effect. 
Some of the factors that affect this “lag” — enumerated 
in previous chapters — are not even considered in cur¬ 
rent discussions of methods for stabilizing prices. Yet, 
even now, some of them can be measured with sufficient 
accuracy to enable us to see that they must be taken into 
account. 4 



CONCLUSIONS 


355 

As Professor Fisher himself points out, it requires time 
for each adjustment of weight to produce the desired ef¬ 
fect; and each adjustment must follow the change in the 
price-level which it is designed to neutralize. For these 
two reasons, if for no other, the plan could bring about 
only approximate stabilization. In any given year slight 
fluctuations would still be inevitable. Even during a 
period such as that from 1896 to 1914, when prices are 
rising not more than two per cent a year, changing the 
weight of the dollar in any given year might not prevent 
a change of two per cent in the price-level. However, if 
the plan could be effective throughout such a period, an 
increase of two per cent a year in the weight of the dollar 
would at least prevent the greater part of the cumulative 
increase in prices. Much more is to be said for “the 
compensated dollar” as a method of controlling the 
secular trend than as a method of controlling cyclical 
fluctuations. 

Such a period, however, presents the problem of sta¬ 
bilization of monetary values only in its simplest form. 
Since 1914, we have discovered that under the Federal 
Reserve System wholesale prices can rise or fall a long dis¬ 
tance in a single year. Apparently, it would be possible, 
at least for a year or two, for the expansion and contrac¬ 
tion of the volume of bank deposits subject to check and 
the volume of Federal Reserve notes to counteract the 
effect of changing the weight of the gold dollar. The 
plan for altering the weight behind each dollar of cur¬ 
rency does not take sufficient account of the fact that the 
price-level is affected by every dollar in circulation, by 
checks on bank deposits as well as by currency. The 
total of gold coin and bullion in the United States on the 
first of January, 1923, was less than four billion dollars, 
while the total amount of currency was more than eight 


MONEY 


356 

billion and the total of bank deposits subject to check 
more than twenty-five billion. And, since the volume 
of bank deposits subject to check and the volume of cur¬ 
rency do not vary directly with the volume of gold coin 
and gold certificates, it would not always be possible even 
approximately to stabilize the price-level during a given 
year merely by changing the weight of gold in the dollar. 
By such a method we do not promptly reach that factor 
which, under the Federal Reserve System, and with our 
present reserve ratio, may at any time become the con¬ 
trolling factor. 

Prices and Federal Reserve Board Policy 

How, then, are we to control the volume of bank de¬ 
posits subject to check in the interests of a stable price- 
level? The agency to which we might naturally look for 
such control is the Federal Reserve Board; but the Board 
has declared repeatedly that it is not concerned with fluc¬ 
tuating price-levels — that its policies should be formu¬ 
lated without reference to past or prospective changes in 
the purchasing power of the dollar. And the Board seems 
to have acted from the outset in accordance with its de¬ 
clared policy. If this is an error, it is one for which we 
should not hold the Board entirely responsible, since the 
provision in the Federal Reserve Act calling upon the 
Board to attempt to stabilize prices was stricken out be¬ 
fore the Act was passed. Possibly, business,men and 
farmers and laborers do not yet know enough about the 
relation of unstable money to their own troubles to be 
willing to have a small group of men, on their own initia¬ 
tive, undertake to control prices. Probably the Board 
should first have enabling legislation by Congress. How¬ 
ever that may be, no one who accepts the conclusions of 
this volume concerning the monetary needs of business 



CONCLUSIONS 


357 


can doubt that the dominant aim of any monetary sys¬ 
tem should be to moderate extreme fluctuations in the 
price-level. A stable money is “sound”: a “sound 
money” is not necessarily stable. Setting aside questions 
of political expediency, and considering only the sus¬ 
tained economic well-being of the people as a whole, we 
must conclude that the chief financial agency of a nation, 
far from ignoring fluctuations in prices, should make them 
the center of interest. There is no service the Federal Re¬ 
serve Board could render to this country — or, indeed, to 
the distracted countries of Europe — that would be com¬ 
parable to its utmost efforts to stabilize the price-level in 
the United States. 

How should the Board proceed in order to do as much 
as possible toward accomplishing this purpose? To an¬ 
swer that question definitely, we need more knowledge 
than we now possess concerning the relation of money to 
prices. The usual discussions of the quantity theory — 
the theory that the price-level varies directly with the 
volume of money, other factors remaining equal — leave 
us without the required knowledge concerning those other 
factors which, as we have seen, never do remain equal. 5 
We must have more extensive quantitative and time stud¬ 
ies of those other factors, correlated with each other and 
with changes in the quantity of money, before the Federal 
Reserve Board or any other agency can do as much as we 
may reasonably hope some day to do toward stabilizing 
the price-level. In particular we should know more about 
the numerous influences, mentioned in the previous chap¬ 
ters, which affect the relation between the flow of money 
into consumers’ hands and the flow of commodities into 
consumers’ markets. Without a clearer insight than we 
now possess, we could not reasonably expect by any 
method of control to attain more than a rough approxi¬ 
mation to stable prices. 


358 


MONEY 


The Rediscount Rate an Insufficient Means of Control 

That is all the Federal Reserve Board could attain by 

means of changes in the rate of rediscount; for the first 

steps toward inflation are not taken by the Board itself. 

The damage is done before the Board is called upon to 

act. At best the rate of rediscount is a tardy regulator. In 

any event, it may not check the expansion of deposits of 

commercial banks as long as those banks have plenty of 

money to lend without resort to the rediscount privilege. 

Furthermore, interest rates affect only the cyclical trend; 

they cannot control a long-trend movement of prices. 

Something more is needed. After the Board had made 

the best possible use of the rate of rediscount, how to 

stabilize the purchasing power of the dollar would still be 

to some extent an unsolved problem. Fluctuations in the 

volume of bank deposits and of Federal Reserve notes 

would still be determined largely by the independent acts 
* 

of thousands of bankers, who know little about the effect 
of their acts upon business in general, and who, in any 
event, are necessarily and properly concerned mainly 
with the safety and profits of their own banks. Their pol¬ 
icies in expanding loans and in contracting loans are not 
determined in the interest of stable prices. On the con¬ 
trary, as we remarked at the close of our discussion of 
speculation, 6 bank credit expands most readily when 
prices are rising and contracts most readily when prices 
are falling, thus accelerating the movement of prices first 
upward and then downward. Inflation can take place 
even though loans are made, in the ordinary course of 
business, strictly in accordance with approved banking 
procedure, on tangible assets of unquestioned value: 7 and 
deflation can take place even when banks are fully meet¬ 
ing what they regard as “the legitimate demands of busi- 


CONCLUSIONS 


359 


ness.” Under our present system, therefore, even though 
the Board made what use it could of the rediscount rate 
as a price stabilizer, the country would still be without 
sufficient protection against fluctuations of prices in a 
given year and with no protection at all against fluctua¬ 
tions over a long term of years. 

Nevertheless, the rediscount rate can always be used as 
a moderating influence. If employed promptly enough, it 
could have prevented the greater part of the rise of prices 
during 1919. The rediscount rate can curb inflation, how¬ 
ever, only if it has the effect of curbing the expansion of 
currency and credit, and to be most effective the rate must 
be higher than the rates of the banks that do the largest 
business with the Reserve Banks. In other words, the rate 
must be such that there is no profit in borrowing from the 
Reserve Banks. On the other hand, if the rediscount rate 
is to curb deflation, the rate must be an adequate incen¬ 
tive to borrowers. As soon as prices begin to fall, there¬ 
fore, the rediscount rate should fall below the bank rate. 
However, the question to what extent and under what 
conditions the rediscount rate can curb deflation requires 
further study. We can only say that if we had the most 
accurate and up-to-date index of prices that it is now 
possible to construct, and if, as the price index changed, 
changes in the rediscount rates were made promptly 
enough , most of the extreme cyclical movements of the 
price-level could be prevented. If changes in rediscount 
rates were thus made strictly in accordance with changes 
in the price-level, business men would know what to ex¬ 
pect and could make future commitments with greater 
assurance. They would welcome such a definite and 
easily understood policy. They need it more than ever 
before. In the past, they have looked upon the reserve 
ratio and the automatic movements of gold in settlement 


MONEY 


360 

of international balances 8 as the best guides to discount 
policy. These guides are not safe to-day. That the reserve 
ratio is no longer a controlling factor is shown by the 
increase of rates early in 1923 by several of the Federal 
Reserve Banks when the reserve ratio was extraordina¬ 
rily high. Business men now have no means of knowing 
what may happen to rediscount rates, or when, or why. 9 

Our Vast Gold Reserves offer a Unique Opportunity 

With nearly four billions of gold, comprising more than 
one third of the monetary gold stocks of the world, the 
United States now has an unprecedented opportunity to 
attain a highly stable price-level, without changing the 
weight of gold in the dollar. A first step might well be to 
use all the gold as a reserve against currency, to make all 
currency legal tender and redeemable in gold, and to abol¬ 
ish all the useless distinctions — mainly relics of political 
compromises and monetary blunders — that survive in 
our “Money in Circulation.’’ 10 We should then have, 
in addition to our subsidiary coins, only one kind of cur¬ 
rency — United States notes. The volume of these notes 
in circulation could be increased promptly as the price- 
level fell and decreased promptly as the price-level rose. 
If an attempt were thus made to stabilize prices at their 
present level, it seems probable that our gold reserves 
would be sufficient to guarantee the convertibility of all 
the currency that would be needed under this plan, for at 
least a generation to come. We should still have “sound” 
money, and we should come much nearer to having stable 
money. 

Under this plan, inflation due to expansion of bank de¬ 
posits subject to check could be curbed shortly after it 
started, for any decrease in the volume of currency in cir¬ 
culation decreases the volume of bank deposits subject 


CONCLUSIONS 


36 r 


to check that can be used to advantage. 11 Moreover, a 
reduction in the volume of circulating currency that was 
sufficient to check a rise in prices would remove the chief 
cause of excessive expansion of bank credit. On the other 
hand, whenever prices began to fall, the additions to the 
currency called for under this plan would tend to bring 
prices back and thus tend to increase the volume of bank 
credit. If, at the same time, changes in the rediscount rate 
were made solely with reference to changes in the price- 
level, there would be two powerful influences working 
together toward the same end, one directly affecting the 
volume of currency, the other directly affecting the vol¬ 
ume of bank deposits. 

Involved in this plan is the practical problem of getting 
currency into circulation and withdrawing it. But this 
surely involves no insuperable difficulties. It might be 
possible for the Government to accomplish this purpose 
by selling securities in the open market whenever prices 
began to rise and buying securities whenever prices be¬ 
gan to fall. 12 Granted a widespread understanding of the 
supreme importance of the aim, and an agreement as to 
the general policy of curbing fluctuations in the price-level 
by means of changes in the volume of currency in circula¬ 
tion, a method could be devised that would go far toward 
achieving the aim. Refinements could come later. And 
they would have to come, as we have said, because we 
cannot achieve the highest attainable degree of stability 
of the price-level until we know more about money as sus¬ 
pended purchasing power; more about the time it would 
require for a given change in the volume of currency, 
brought about by a given method, to produce the desired 
result; and, especially, more about the factors that affect 
the flow of money into consumers’ hands. 

There is now no other equally good use to which we can 


362 


MONEY 


put these vast gold reserves, at home or abroad. At home, 
they are a menace to business. Unless measures are taken 
to prevent their use as a basis for further inflation, we 
have reason to expect a return to the hectic “prosperity” 
and high peaks of 1919, followed by another depression as 
disastrous as that of 1920 and 1921. Abroad, in those 
countries where our gold is most needed as a means of 
stabilizing currencies, there is no immediate prospect of 
having it used for that purpose. In the present demoral¬ 
ized condition of European currencies, there appears to 
be no way of sending gold to Europe with any likelihood 
that it will stay there and function as in pre-War times. 
Our gold reserves will best serve the immediate needs of 
the world, if they are used at home in such a way as to 
provide a fairly stable, gold price-level, which the whole 
world can use as a standard, and which is likely to remain 
a standard at least for a generation to come. A large part 
of the world is already making some use of the United 
States gold dollar as a measure of value. It would be 
much more useful if it were a dependable measure. 

An Emergency Measure that might help 

Even without enabling legislation and without delay, 
the Federal Reserve Board could set aside a billion dollars 
or more of gold as a “reserve against contingencies.” 9 
This special reserve might be earmarked “for export.” In 
this way the Board could emphasize the fact that the time 
may come when this gold will best serve the economic 
world by being shipped abroad, and should not now be 
used as a basis for further inflation. Under this plan, the 
reserve ratio — reduced to 50 or even lower — would be a 
less urgent invitation to expand bank deposits. To be 
sure, most of the “easy money” advocates, in Congress 
and out, would know that this gold, even with a new 


CONCLUSIONS 


363 


name and a new place In the Treasury reports, was still 
available as a basis for currency and credit expansion; and 
there would be just as many people who regarded their 
own need of more money as a sufficient “ contingency” to 
demand expansion. Setting aside a part of the reserves in 
this way is not enough. Nevertheless, an official declara¬ 
tion of such a policy on the part of the Board might help 
to curb inflation now, and also help to convince the coun¬ 
try of the need of a still more definite and more effective 
price-control policy. 

How much Money does Business need? 

In answer to the question how much money is enough 
to meet the needs of business, there have been innumera¬ 
ble answers. They have been amazingly diverse and often 
in direct contradiction of each other. Petty declared that 
a nation needed only “so much as will pay half a year’s 
rent for all the lands of England and a quarter’s rent of 
the Houseing, for a week’s expense of all the people and 
about a quarter of the value of all the exported commodi¬ 
ties.” This estimate seems in our day about as scientific 
as the conjectures of medieval philosophers concerning 
the number of angels that could stand on the point of a 
needle. As late as the time of Locke, the estimates were 
equally crude. Locke, himself, thought that “one fiftieth 
of wages and one fourth of the landowner’s income and 
one twentieth part of the broker’s yearly returns in ready 
money will be enough to drive the trade of any country.” 
In the eighteenth century, Cantillon came to the conclu¬ 
sion that the country needed enough money in value to 
equal a ninth of the total produce of the country or, what 
he estimated to be the same thing, a third of the rent of 
the land. 

Underlying the development of currency and banking 


364 


MONEY 


systems in the United States has been the assumption 
that in the ordinary course of business there are sure to be 
wide variations in the volume of trade. Based on this 
assumption, there has been a persistent demand for a cur¬ 
rency that is ‘"sufficiently flexible to satisfy the legitimate 
changing demands of business.” Frequently, as we have 
already remarked, 13 the cry is for “enough money to do 
business with ”; often for “a credit system that is respon¬ 
sive to the fluctuating requirements of commerce”; and 
oftener still merely for “an elastic currency.” This de¬ 
mand, in one form or another, appears regularly. The ex¬ 
pressions of this demand, though many and various, have 
the common characteristic of vagueness: they deal with 
quantitative terms without quantitative precision. They 
do not grapple with the question “How much?” No¬ 
where do they offer us a reliable measure of “trade re¬ 
quirements” or of “the legitimate demands of business.” 
Nowhere do they tell us by what means we are to deter¬ 
mine precisely how much money, at any given time, will 
satisfy “legitimate demands.” Some men insist that un¬ 
der our banking system there is no possibility of getting 
enough money in circulation. Others assume that our 
currency and bank credit are sure to have the proper 
degree of elasticity whenever expansion and contraction 
occur in the ordinary course of business. 14 

When, however, we use even such means as are now 
available for measuring our volume of business, we find 
that it does not vary greatly from year to year. Decade 
after decade, the volume of production in the United 
States has increased at an average rate not far from four 
per cent per annum. 15 And the volume of trade — except 
when speculative dealings are stimulated by increases of 
money out of proportion to increases of production, or 
when a period of depression ensues — varies at about the 


CONCLUSIONS 


365 

same rate as the volume of production. The wide fluctua¬ 
tions in the state of business activity which we pictured in 
our opening chapter are not measures of changes in the 
volume of trade in consumers’ markets. On the contrary, 
these extreme fluctuations in general business activity are 
themselves due chiefly to fluctuations in the volume of 
currency and bank credit which have taken place with¬ 
out reference to changing trade needs. We are justified, 
therefore, in concluding that an increase of about four per 
cent per annum in the total volume of currency and bank 
credit in circulation would come much nearer to satisfy- 
ing the legitimate needs of business” than increases 
which come about, as in 1915 to 1919, through the inde¬ 
pendent activities of thousands of banks and hundreds of 
thousands of their customers, operating under our present 
banking system. It seems not unlikely that if the Govern¬ 
ment put additional currency promptly into circulation as 
prices began to fall, and withdrew currency promptly 
as prices began to rise, the net result over a decade or two 
would be an increase of currency and credit in circulation 
at the average rate of not far from four per cent a year. If 
we used the best indexes that could be made both of prices 
and of production, probably it would make little differ¬ 
ence, in a given decade, whether changes in the currency 
were based upon changes in prices or upon changes in the 
volume of production. For a few years, a combined index 
of prices and production might be used as a base, or a com¬ 
posite of various other weighted indexes. In the long run, 
however, the only safe guide to changes in the volume of 
currency is the price-level. 

A century ago, Adam Smith commented on the fact 
that various writers had computed the amount of money 
needed by business as a tenth, a twentieth, and a thirti¬ 
eth part of the whole value of the annual produce; and he 


MONEY 


366 

concluded that “It is impossible to determine the propor¬ 
tion.” When he wrote, Adam Smith was right; for in his 
time there were no means of measuring the factors that 
determine the amount of money a nation needs. But 
now that we have fairly precise measures of the price- 
level, on the one hand, and the volume of employment 
and production on the other hand, we have the means of 
determining in a scientific manner how much money busi¬ 
ness needs. For, if we are right in our conclusion that 
the paramount monetary need of business, decade after 
decade, is a stable price-level, it follows that — once max¬ 
imum employment and production have been attained — 
the amount of money required by business as a whole is 
the amount which will insure the highest attainable 
degree of stability of prices. Whatever amount will 
achieve this end is “enough money to do business with.” 
More is too much — inflation: less is not enough — 
deflation. 

At what Level should Prices be stabilized? 

At what level should the attempt be made to stabilize 
prices? That is a question we now hear every day; but it 
is not the most pertinent question. The level matters lit¬ 
tle. As we said early in our discussions, business can pro¬ 
ceed as steadily on one price-level as on any other level, 
once the change has been made, just as a ship can sail as 
serenely on Lake Superior as on the lower level of Lake 
Huron once it has passed through the locks. It is the 
process of changing levels and the frequency of the change 
that retard progress. The pertinent question is, In what 
stage of the business cycle should we attempt to stabilize 
prices? Certainly not at any stage in which the volume of 
employment and production can be increased by a rise in 
prices. We have noted the fact, however, that in the up- 


CONCLUSIONS 


367 

ward swing of the cycle, the stage is reached, sooner or 
later, in which rising prices and rising wages cannot in¬ 
crease the volume of employment and actually decrease 
the volume of production. 16 No matter what the level of 
prices happens to be, therefore, it is the right time to at¬ 
tempt to stop further changes when employment and pro¬ 
duction have reached a maximum. How can we tell when 
that stage has been reached? From our available indexes 
of employment and our available indexes of production, 
we cannot tell exactly. 17 There is nothing, however, ex¬ 
cept a recognition of the importance of these measures, to 
prevent us from making them as nearly accurate as need 
be; and, compared with the losses we are seeking to pre¬ 
vent, the cost of perfecting these measures and keeping 
them up-to-date would be trifling. Even with the imper¬ 
fect indexes at hand, it seemed probable, early in 1923, 
that further increases in the volume of currency and 
credit in circulation would prolong the period of rising 
prices, with its attendant evils and prospective collapse, 
without increasing the volume of employment and pro¬ 
duction. 

Conclusion 

Periodically, the economic organization of society 
proves defective: men, materials, and machines, ready to 
do their part, are not brought into such relations that 
they can go on with the world’s work. This is the com¬ 
monplace remark with which we opened our discussion of 
“ Money.” These recurrent business depressions, we ob¬ 
served, have caused economic losses in the United States 
greater than the incomes of all our millionaires, and losses 
other than economic of which we are all aware, but for 
which we have no measure. How to prevent these losses 
— how to keep our machinery moving at maximum pro- 


MONEY 


368 

ductivity and the products moving into consumption at 
the same rate — is the economic problem. 

The problem can be solved. 18 There is no evidence that 
the alternation of prosperity and gloom is due, like the 
procession of the seasons, mainly to natural causes over 
which man has no control. Neither is it possible to dis¬ 
cover any major influences, inherent in human nature or 
in the nature of business, that cannot be sufficiently mod¬ 
erated by human insight and decision. The chief factors 
in business fluctuations, as we have shown, can be meas¬ 
ured with a high degree of precision and are much more 
amenable to human control than has seemed possible in 
the past. Dominant among these factors is money. But 
money cannot be controlled as it should be controlled 
until we know more about the exact ways in which it 
helps and hinders all the processes of production and dis¬ 
tribution. In the present volume, we have done little 
more than analyze those characteristics of the established 
monetary economy which must be taken into account 
before it is possible for any one to discover how to keep 
the machinery going. Even this incomplete analysis, we 
hope, may have a part in stimulating others to think 
their way further into the intricacies of the problem. 


THE END 


APPENDIX 





APPENDIX 

NOTES TO ALL CHAPTERS 

Chapter I 

1. Figure i is based on a chart prepared by the American Telephone 
and Telegraph Company to show fluctuations in the state of 
business activity. This chart does not represent changes in the 
volume of trade. Statistics for bank clearings, postal receipts, 
long-distance telephone calls, and retail sales during 1921 (as Carl 
Snyder has pointed out) indicate that the total volume of business 
transactions for this year of depression was not much smaller — 
certainly not eight per cent smaller — than for the previous year. 
Nevertheless, the economic loss to society due to cyclical fluctua¬ 
tions in employment is far greater than statistics of the volume of 
trade would seem to indicate. Probably, Figure 1 does not make 
that loss appear any larger than it really is. 

“The Board of Trade statistics for this country give an average 
rate of unemployment amounting to little over 4 per cent for the 
trades brought under survey, and varying from somewhat below 2 
per cent in ‘boom’ years to 10 per cent and over in depressions. 
But we have here no even approximate measure of the real waste 
of productive power. For, quite apart from the fact that unskilled 
labour, women’s labour, and in general casual labour, where the 
wastes are greatest, do not count in their true proportions in the 
basis of the official figure, there are two wastes of immense and 
immeasurable magnitude of which no account is taken. To one I 
have already made allusion, the waste of capital, skill and labour 
normally involved in the practice of ‘ca’ canny ’ or slowing down of 
production, due to a fear on the part of employers of glutting the 
market, on the part of workmen of unemployment.” (J. A. Hob¬ 
son, Economics of Unemployment , London, 1922; pp. 24-25.) 

The close correspondence between volume of employment and 
volume of production has been shown by William A. Berridge, in 
his Poliak Prize Essay, Cycles of Unemployment in the United 
States, 1903-1922. (Poliak Publications, Number 4.) 

2. Prices are treated as the core of economic theory in Professor 
H. J. Davenport’s The Economics of Enterprise, one of the most 
stimulating and readable of all the general treatises. He says: 

“The problem of market price is the central and unifying prob¬ 
lem of present-day economics.” 


372 


MONEY 


“In its theoretical aspects, the science of economics is, indeed, 
but little more than a study of price and of its causes and its corol¬ 
laries.” 

“The theory of price is thus the core of all economic theory; the 
rest is corollary or application.” 

“Men are essentially cooperative and interdependent in their 
productive activities; their antagonisms attach solely to the price 
aspects of the competitive system, its trading process, and mani¬ 
fest themselves in the effort to obtain through trading the most 
possible for the least possible.” (H. J. Davenport, The Economics 
of Enterprise, New York, 1919; pp. 25-40.) 

Another writer says: “Money is the pivot of everything in 
economics. We cannot move a single step towards the elucidation 
of any of its problems without first studying the nature and opera¬ 
tion of the standard substance.” (William Warrand Carlile, 
The Evolution of Modern Money, New York, 1901; p. 325.) 

3. John Stuart Mill, Principles of Political Economy, Ashley’s edition, 
New York, 1895; p. 6; p. 488. 

4. The usual treatment of the functions of money is the one found in 
W. Stanley Jevons, Money and the Mechanism of Exchange, chap. 
hi. 

The term “money,” as explained in Chapter II, is employed 
throughout the present volume, in accordance with ordinary busi¬ 
ness usage, to include all forms of currency and bank credit. 

5. Joseph F. Johnson, Money and Currency, Boston, 1905; p. 39. 

Dr. R. Estcourt says (in the Annalist, New York, December 
18, 1922; p. 660): “The textbooks all go back to the history of 
the introduction of money as a medium of exchange and fail to 
distinguish between that fact and modern conditions. They treat 
the whole subject as if the conditions of a thousand years ago were 
still in operation. What is taught about money is quite correct, 
but it appertains to the history of finance and should be clearly 
shown to have no educational value except as history.” John 
Raymond Cummings, says: “The science of astronomy was im¬ 
possible until we learned that the earth revolves and the sun is the 
center. The science of money hitherto has been like the Ptolemaic 
system of the universe in its makeshift complications.” (Natural 
Money, New York, 1912; p. 7.) 

6. T. N. Carver, Principles of Political Economy, Boston, 1919; p. 292. 

7. E. Levasseur, Elements of Political Economy (Translation by 
T. Marburg), New York, 1905; p. 185. 

8. F. A. Fetter, Economic Principles, New York, 1915; p. 51. 

9. J. R. Turner, Introduction to Economics, New York, 1919; p. 284. 

10. F. T. Carlton, Elementary Economics, New York, 1920; p. 91. 


NOTES TO CHAPTER II 


373 

11. Horace White, Money and Banking (fifth edition), Boston, 1911; 
p. 2; p. 9. 

12. J. Laurence Laughlin, Principles of Money , New York, 1903; 
P- 536 . 

13. H. J. Davenport, The Economics of Enterprise , New York, 1919; 
p. 4. 

14. Henry Clay, Economics for the General Reader (American edition), 
New York, 1918; p. 188. 

15. Hugo Bilgram and L. E. Levy, The Causes of Business Depressions, 
Philadelphia, 1919; p. 38; p. 53. 

16. F. A. Fetter, American Economic Review, December, 1920; p. 724. 

17. Wesley C. Mitchell, “The Role of Money in Economic Theory,” 
in the Proceedings of the Twenty-Seventh Annual Meeting of the 
American Economic Association. 

18. Alfred Marshall, Principles of Economics (seventh edition), Lon¬ 
don, 1916, p. 782. 

19. R. G. Hawtrey, in The Economic Journal, London, September, 
1922; p. 298. 

Chapter II 

1. Joseph F. Johnson, Money and Currency, Boston, 1914; p. 6. 

2. J. Shield Nicholson, Money and Monetary Problems (sixth edition), 
London, 1900; p. 108. 

3. “ Much ingenuity has been spent upon attempts to define the term 
money. . . . All such attempts at definition seem to me to involve 
the logical blunder of supposing that we may, by settling the mean¬ 
ing of a single word, avoid all the complex differences and various 
conditions of many things, each requiring its own definition. 
Bullion, standard coin, token coin, convertible and inconvertible 
notes, legal tender and not legal tender, cheques of several kinds, 
mercantile bills, exchequer bills, stock certificates, etc., are all 
things capable of being received in payment of a debt, if the 
debtor is willing to pay and the creditor to receive them; but they 
are, nevertheless, different kinds of things. By calling some money 
and some not, we do not save ourselves from the consideration 
of their complex legal and economical differences.” (W. Stanley 
Jevons, Money and the Mechanism of Exchange, New York, 1892; 
p. 248.) 

4. The operation of the Federal Reserve System is explained in 
Banking and Business, H. Parker Willis and George W. Edwards, 
New York, 1922; chap. xxvi. 

According to the report of the United States Treasury Depart¬ 
ment, the total stock of monetary gold and currency in the United 
States (as the term “currency” is used in this book) was as follows 
on the first of January, 1923: 


374 


MONEY 


United States Circulation Statement — January i, 1923. 


(/» millions of dollars ) 


Kind of Money 

Total 

Stock 

of 

Money 

Money held in the Treasury 

Total 

Amount 

held 

against 

Certifi¬ 

cates 

Reserve 

against 

United 

States 

Notes 

Held for 
Federal 
Reserve 
Banks 

All 

other 

money 

Gold Coin and Bullion. 

$ 3)933 

708 

441 

344 

1 

269 

346 

2,817 

43 

762 

$3,284 

$708 

$152 

$2,235 

$187 

Standard Silver Dollars. 

373 

345 



27 








12 

3 

2 

I 

17 




12 

3 

2 

I 

17 









Federal Reserve Bank Notes .. 







Total January i, 1923. 

Comparative totals: 

December 1, 1922. 

January 1, 1922. 

April 1, 1917. 

July i, 1914. 

January 1, 1879. 




8,614 

3,696 

1,053 

152 

2,235 

253 

$8,482 

8,282 

5,312 

3,738 

1,007 

$ 3,677 

3,351 

2,942 

1,843 

212 

$1,019 

990 

2,684 

1,507 

21 

$152 

152 

152 

150 

100 

$2,215 

1,933 

$289 

274 

105 

186 

90 


Kind of Money 

Money Outside the Treasury 

Population 

(Esti¬ 

mated) 

Total 

Held by 
Federal 
Reserve 
Banks 

In Circulation 

Amount 

Per capita 

Gold Coin and Bullion. 

$649 

$219 

$429 

$3-88 


Gold Certificates. 

708 

405 

302 

2.74 


Standard Silver Dollars. 

68 

6 

61 

.56 


Silver Certificates. 

344 

55 

288 

2.61 


Treasury Notes of 1890. 

1 


1 

.01 


Subsidiary Silver. 

256 

10 

245 

2.23 


United States Notes. 

342 

56 

286 

2.59 


Federal Reserve Notes. 

2,814 

441 

2,372 

21.46 


Federal Reserve Bank Notes 

42 

5 

36 

33 


National Bank Notes. 

744 

36 

707 

6.40 


Total January 1, 1923. 

5,972 

1,239 

4,732 

42.81 

110 

Comparative totals: 






December x, 1922. 

$5,824 

$1,208 

$4,616 

$41.80 

IIO 

January 1, 1922. 

5,920 

1,399 

4,521 

4 I. 5 I 

108 

April 1, 1917. 

5,053 

953 

4,100 

39.54 

103 

(July x, 1914. 

3,402 


3,402 


nn 

(January 1, 1879. 

’816 


816 

16.92 

yy 

48 


Note. Gold certificates are secured dollar for dollar by gold held in the Treasury*for their 
redemption; silver certificates are secured dollar for dollar by standard silver dollars held in 



















































































































NOTES TO CHAPTER III 


375 

» 

the Treasury for their redemption; United States notes are secured by a gold reserve of $152,- 
979,025.63 held in the Treasury. This reserve fund may also be used for the redemption of 
Treasury notes of 1890, which are also secured dollar for dollar by standard silver dollars, 
held in the Treasury. Federal Reserve notes are obligations of the United States and a first 
lien on all the assets of the issuing Federal Reserve bank. Federal Reserve notes are secured 
by the deposit with Federal Reserve agents of a like amount of gold or of gold and such dis¬ 
counted or purchased paper as is eligible under the terms of the Federal Reserve Act. Federal 
Reserve banks must maintain a gold reserve of at least 40 per cent, including the gold redemp¬ 
tion fund which must be deposited with the United States Treasurer, against Federal Reserve 
notes in actual circulation. Federal Reserve bank notes and National bank notes are secured 
by United States Government obligations, and a 5 per cent fund for their redemption is 
required to be maintained with the Treasurer of the United States in gold or lawful money. 

Chapter III 

1. Henry Clay, Economics for the General Reader (American edition), 
New York, 1918; p. 153. 

2. Henry R. Seager, Introduction to Economics (third edition), New 
York, 1905; p. 7. 

3. Edwin R. A. Seligman, Principles of Economics (eighth edition), 
New York, 1919. 

4. H. G. Moulton, The Financial Organization of Society , Chicago, 
1920; p. 743. 

“The pecuniary unit of calculation, together with the medium 
of exchange and the standard of deferred payments, have not only 
made possible but have been responsible for the development of 
our large scale cooperative exchange society.” 

5. R. H. Patterson, The New Golden Age, Edinburgh, 1882; vol. 1. 

6. Verney L. Cameron, All Across Africa, vol. 1. See, also, W. Stanley 
Jevons, Money and the Mechanism of Exchange, New York, 1892; 
p. 1. 

7. H. J. Davenport, Economics of Enterprise, New York, 1919; 

P- 237 - 

8 . Ibid. 

9. B. M. Anderson, Jr., The Value of Money, New York, 1917; p. 197. 

10. Ibid., p. 201. 

11. See Chapter X, below. 

12. The Electrical World (November 4, 1922; p. ion) says: “In some 
parts of Germany the inhabitants have, as a result of the demorali¬ 
zation of the currency, reverted to barter in business transactions. 
This tendency is said to have reached even the electric supply 
companies, and at Auma, a fairly populous village, the Saxon 
Thuringian Power Company has announced its willingness to ac¬ 
cept, instead of cash, ten eggs, 3 pounds of wheat flour or quarter 
of a centner (about 27 pounds) of potatoes for each kilowatt-hour 
of electricity consumed.” Needless to say, this is a cumbersome 
and costly resort of business, in a country where the Government 
has all but destroyed the usefulness of money as a medium of 
exchange. 


MONEY 


376 

Chapter IV 

1. Joseph Szebenyei, Atlantic Monthly , March, 1922. 

2. Readers of economic textbooks are sometimes led to overlook the 
importance of the instability of money by such sentences as the 
following: 

“We may throughout this volume neglect possible changes 
in the general purchasing power of money.” (Alfred Mar¬ 
shall, Principles of Economics (seventh edition), London, 1916; 
p. 62.) 

Money is “the only commodity of which we may say that its 
abundance or scarcity is a matter of perfect indifference.” (Charles 
Gide, Principles of Political Economy , Boston, 1904; p. 220.) 

“Gold and silver... are generally desired, independently of 
their money use. . .. This fact gives them security and stability 
of value.” (Richard T. Ely, Elementary Principles of Economics, 
New York, 1904; p. 228.) 

“Credit furnishes for currency the only element of ready adapt¬ 
ability. It furnishes, for ordinary conditions, the guaranty of 
steady market prices.” (H. J. Davenport, Economics of Enterprise , 
New York, 1919; p. 282.) 

“Another reason why money is usually preferred as a medium 
of credit transaction is because of its stable value. Both debtor 
and creditor, then, enjoy a reasonable protection.” (Charles M. 
Thompson, Elementary Economics , New York, 1919; p. 204.) 

“Since gold is the commodity whose value fluctuates from natural 
causes probably least of all, the importance of protecting creditors 
against loss from these slight fluctuations is less pressing than is 
often claimed.” (Bilgram and Levy, The Cause of Business De¬ 
pressions , Philadelphia, 1914; p. 36.) 

It goes without saying that isolated sentences sometimes give 
an erroneous idea of an author’s views. These quotations are 
offered merely to show that the general reader frequently comes 
across statements that give him a false sense of security in mone¬ 
tary “standards.” 

3. Alfred Marshall, Principles of Economics (seventh edition), 
London, 1916; p. 793. 

4. William Warrand Carlile, The Evolution of Modern Money , New 
York, 1901; p. 315. 

5. Figure 3 is taken from the first number of the Stable Money 
Graphic , issued by the Stable Money League (now the National 
Monetary Association), May, 1922. The dollar for 1865 in this 
chart was not a “gold dollar.” 

Figure 4 is based on statistics compiled, by the Federal Reserve 
Bank of New York, from the United States Bureau of Labor Index 


NOTES TO CHAPTER V 


377 

of Wholesale Prices and the Circulation Statements of the Treasury 
Department. 

Figure 7 (Chapter IX) is a map of Europe showing the different 
degrees of depreciation of “standards of value” in different coun¬ 
tries at the same time. 

6. Augustus Sauerbeck, The Course of Average Prices of General 
Commodities in England , London, 1908. 

7. The Commercial and Financial Chronicle , November 26, 1921; 

p. 2234* 

8. Ibid., June 11, 1921; p. 2464. 

Chapter V 

1. Bertil Ohlin, The Rise of Prices, Inflation and Foreign Exchange 
Policy, Ekonomisk Tidskrift, Uppsola and Stockholm 1921, 
No. 3. The objections to Bertil Ohlin’s definition are considered 
at greater length in Chapter X. 

2. “Without attempting to harmonize the various conflicting views, 
nor to give a precise and formal definition of inflation, we may note 
that there is one idea common to most uses of the word, namely, 
the idea of a supply of circulating media in excess of trade needs. 
It is the idea of redundancy of money or circulating credit or both, 
a redundancy that results in rising prices. . . . More specifically, 
inflation occurs when, at a given price-level, a country’s circulating 
media — cash and deposit currency — increase relatively to trade 
needs.” (E. W. Kemmerer, “Inflation,” American Economic 
Review, June, 1918; p. 247.) To us it seems unnecessarily confusing 
to introduce “trade needs” into the definition — business men 
have so many different conceptions of “trade needs.” According 
to our definition, inflation occurs, no matter how we define “ trade 
needs,” when, at the same time, the volume of money increases 
and the price-level rises. 

The Federal Reserve Bulletin (July 1, 1919; p. 614) defines 
inflation as “the process of making addition to currencies not 
based on a commensurate increase in the production of goods.” 
One trouble with this definition is that volume of trade is a better 
index of currency needs than volume of production. However, in 
any given decade, if there was inflation in our sense of the term, 
there would be inflation in the Federal Reserve sense. This is due 
to the fact that in a given business cycle, considered as a whole, 
variations in the volume of trade are likely to be about the same 
as variations in the volume of production. This would not hold 
true for very much shorter or for very much longer periods of time. 

It is true that, without more inclusive and more accurate index 
numbers of prices than are now available, we might have inflation 


378 


MONEY 


to a small extent without discovering it in the relation between 
volume of money and prices. 

3. Inflation, says Professor Seligman, is “the existence of a currency 
in a quantity larger than is actually needed to carry on business 
transactions at a normal price-level.” But he adds that, during 
the War, “ to the extent that the increase of money and credit kept 
pace with the dislocation in the conditions of production and con¬ 
sumption, there was a rise in prices without there being any in¬ 
flation.” This statement appears to be inconsistent with his defini¬ 
tion. It involves us, furthermore, in the current confusion con¬ 
cerning the causes of rising prices, which confusion is due in part 
to the prevailing false assumption that there is a balanced relation 
between new business and new bank credit created to finance it. 
That there is an exact correspondence between the volume of com¬ 
mercial transactions and the amount of money ordinarily placed in 
circulation in connection with these transactions, is frequently 
asserted and even more frequently assumed. It appears, however, 
from the evidence presented in the following chapters, that the 
assumption is unwarranted. (See Edwin R. A. Seligman, Currency 
Inflation and Public Debts , The Equitable Trust Company, New 
York, 1921; pp. 9-10.) 

4. See W. T. Layton, An Introduction to the Study of Prices , Appendix 
C, on “The Vicious Circle of Prices,” New York, 1912. 

5. “The currencies of all belligerent, and of many other countries, 
though in greatly varying degrees, have since the beginning of the 
War been expanded artificially, regardless of the usual restraints 
upon such expansion (to which we refer later) and without any 
corresponding increase in the real wealth upon which their pur¬ 
chasing power was based; indeed, in most cases, in spite of a 
serious reduction in such wealth. . . . Where this additional cur¬ 
rency was procured by further ‘inflation’ (i.e., by printing more 
paper money or creating fresh credit) there arose what has been 
called a ‘vicious spiral’ of constantly rising prices and wages and 
constantly increasing inflation, with the resulting disorganization 
of all business, dislocation of the exchanges, a progressive increase 
in the cost of living, and consequent labor unrest.” (From the 
resolutions of the National Monetary Conference at Brussels. 
Federal Reserve Bulletin , December, 1920; p. 1284.) 

The Bankers' Magazine , London, said in January, 1921, p. 51: 
“It is instructive to trace how successive issues of currency notes 
have formed the cash basis of still further credit by the banks and 
thus increased the total level of bank deposits without the creation 
of any corresponding value to justify the increase. A similar effect 
resulted from the requests made to the banks to subscribe a portion 


NOTES TO CHAPTER VI 379 

of the war loans. These subscriptions, instead of reducing deposits, 
had the effect of increasing them as soon as the Government dis¬ 
bursed the proceeds, thus aggravating the inflation and causing 
general prices to rise to a still higher level. The effect on national 
welfare is far-reaching.” 

Another clear analysis of the vicious spiral of inflation and de¬ 
flation is found in Alfred Marshall, “Money, Credit and Com¬ 
merce,” London, 1923; pp. 18-20. 

6. Pelatiah Webster, Political Essays , 1791; p. 175, note. See also, 
Francis W. Hirst, The Paper Moneys of Europe, Boston, 1922. 

7. John Stuart Mill, Political Economy, New York, 1895; Book in, 
chap. vil. 

8. Sir Lancelot Hare, A Study of Exchange, London, 1921; pp. 35-38. 

9. Andrew D. White, Paper Money Inflation in France; How it Came, 
W hat it Brought, and How it Ended, New York, 1882; p. 44. 
See, also, J. S. Nicholson, Inflation, London, pp. 83-85; and H. H. 
Powers, “The Drug Habit in Finance,” Atlantic Monthly, January, 
1923. 

10. United States Consular Reports, No. 68, September, 1885^.653. 

11. Joseph Szebenyei, Atlantic Monthly, March, 1922. 

12. Sir Henry Penson, Is Germany Prosperous? London, 1922. Con¬ 
cerning the results of inflation in Germany see, also, George W. 
Edwards, “ Effects of the Price Revolution on Germany,” Annalist 
(New York), November 27, 1922; p. 565. 

13. Carl Snyder, “War Loans, Inflation and the High Cost of Living,” 
Annals of the American Academy, vol. lxxv, No. 164, January, 
1918; p. 143. 

14. C. H. Northcott, “Unemployment Relief Measures in Great 
Britain,” Political Science Quarterly, September, 1921; p. 432. 

15. Joseph F. Johnson, in The Economic World , December 16, 1922; 
p. 869. 

16. T. R. Jernigan, United States Consular Reports, No. 68, Septem¬ 
ber, 1886; p. 653. The results of deflation are also described by 
Irving Fisher (“Business Depression and Instability of Money”) 
in the Bankers ’ Magazine, January, 1922. 

17. Gustav Cassel, The World's Monetary Problems, London, 1921; 
p. 66. See, also, John Foster Bass and Harold Glen Moulton, 
America and the Balance Sheet of Europe, New York, 1921; p. 
90; and Fabian Franklin, Annals of the American Academy, May 
7, 1920; p. 89. 

Chapter VI 

1. W. Stanley Jevons, Money and the Mechanism of Exchange, New 
York, 1892; p. 40. 


380 


MONEY 


2. Dearborn Independent, March n, 1922. 

3. Ibid., March 25, 1922. 

4. Ibid., March 25, 1922. 

5. Ibid., March 18, 1922. 

6. Thomas A. Edison, Questionnaire in the New York World, Febru¬ 
ary 19, 1922. See, also, The Nation's Business, May, 1922; p. 16. 

7. Dearborn Independent, March 18, 1922. 

8. H. C. Cutting, The Strangle Hold, Chicago, 1921; p. 53. See, also, 
The Palladium, September, 1921; p. 1. 

9. Dearborn Independent, March 18, 1922. 

10. H. L. Loucks, The Great Conspiracy, Watertown, S.D., 1916; p. 27. 

11. P. and A. Wallis, in Prices and Wages, because they err fundamen¬ 
tally in their conception of price-determination, overlook all the 
shortcomings of labor-hours as units of exchange. On page 221, 
they advance the usual fallacious reasoning on this subject: “So 
that their price might be quoted in hours of labor and all business 
exchanges made with hours as the basis of price, a paper currency 
could be made in notes of various time-values, and a ‘one-day 
note ’ could be paid for a day’s work and exchanged as a legal ten¬ 
der for any kind of goods that took an average day’s work to pro¬ 
duce; in fact, perform all the functions of money quite as well as, if 
not better than, our present currency. It would have the great 
advantage that the standard was really a fixed one and not sub¬ 
ject to variations that could affect prices.” 

W. E. Brokaw says, in the Equitist: “ If we would adopt a work- 
unit money; that is, require that every dollar issued be issued 
solely for an hour’s adult human work, and promise that it will be 
accepted in return for an hour’s adult human work, no one could 
receive money for anything but human work, and no one would 
have to pay money for anything but human work. Which would 
stop all tribute now going to the people who own for their in¬ 
comes. It would put an end to millionaire ownership and to 
pauperism.” 

12. H. L. Loucks, The Great Conspiracy, Watertown, S.D.,1916; p. 35. 

13. Thomas A. Edison, Questionnaire in the New York World, Feb¬ 
ruary 19, 1922. 

14. Senate Bill 2604, 67th Congress, 1st Session; Introduced by Sena¬ 
tor Ladd, October 14, 1921. 

15. Excellent discussions of the gold basis of money are found in the 
Monthly Bulletin of the National City Bank of New York, for 
March and April, 1922. 


Chapter VII 

1. The New York Times, July 16, 1922; section 7. See, also, “Edison’s 


NOTES TO CHAPTER VIII 381 

Proposed Plan for Financing Agriculture,” Manufacturers' Record , 
July 27, 1922; pp. 59-62. Mr. Edison has presented his plan in a 
pamphlet, under the title “A Proposed Amendment to the Federal 
Reserve Banking System,” Orange, N.J., 1923. 

2. During the period of inflation following the War, there were many 
cases of bank credit extended more than once on the same goods. 
See Paul Warburg, Acceptances in Our Domestic and International 
Commerce , published by the American Acceptance Council; p. 23. 

3. H. C. Cutting, The Strangle Hold , Chicago, 1921; p. 79. 

4. C. J. Melrose, Money and Credit , London, 1922. 

5. Dearborn Independent , March 25, 1922. 

6. Harrison H. Brace, The Value of Organized Speculation , Boston, 
1913; Appendix. 

7. Figure 5 was prepared by the Federal Reserve Bank of New York, 
from the Wholesale Price Index (aggregate of weighted prices) of 
the War Industries Board. The twenty basic commodities are: 
wheat, corn, hogs, steers, sugar, hides, wool, silk, cotton, rubber, 
pig-iron, copper, lead, coal, petroleum, southern yellow pine, ce¬ 
ment, paper, sulphuric acid, tobacco. 

8. Augustus Sauerbeck, The Course of Average Prices of General 
Commodities in England , London, 1908. 

9. The Better Banking Bureau, of San Francisco, for example, errs 
in maintaining that the reason why bank credit does not fluctuate 
in volume with the volume of business is because of the gold 
standard. See H. C. Cutting, The Strangle Hold , Chicago, 1921; 
p. 98. 

10. Wesley C. Mitchell, United States Bureau of Labor Statistics, 
Bulletin No. 284, October, 1921; p. 95. 

11. Irving Fisher, Stabilizing the Dollar , New York, 1920. Professor 
Fisher’s plan is discussed in Chapter XXL 

12. The World , New York, February 19, 1922. 

Chapter VIII 

1. Dearborn Independent , July 22, 1922. 

2. Dearborn Independent , May 13, 1922. 

3. Chapter II, above. To say that interest rates are determined by 
supply and demand is merely to begin the discussion of one of the 
most intricate of economic problems. The question remains, 
What are the factors that determine supply and demand? But 
this question has nothing to do with the justice of charging interest, 
which is the subject of our chapter. 

The Palladium , of which W. H. (Coin) Harvey is editor, says 
(January, 1923) that each State should establish a bank that will 
“pay no interest on money deposited with it,” and on loans “will 


382 


MONEY 


not charge to exceed at the rate of four per cent per annum.” The 
existence of such a bank, it is said, “calls attention to the Divine 
Law and moral precept that it is a sin to either pay or receive in¬ 
terest on money except by the sovereign power.” The Palladium 
fails to explain, however, by what means the State is to obtain 
deposits if it pays no interest, when the Federal Government can¬ 
not obtain the use of money for less than three or four per cent. 
Nor does The Palladium explain how we are to fill political offices 
with men who are wise enough to allocate the loans justly, at an 
artificially low rate of interest, when at that rate there would not 
be enough money to go around. These are the fundamental 
difficulties that confront all those who are seeking to abolish in¬ 
terest or to fix interest rates by law. 

4. See, also, Monthly Bulletin of the National City Bank of New 
York, July, 1922. 

5. Dearborn Independent, August 19, 1922. 

6. Chapter II, above; page 20. 

7. In this connection see Gustav Cassel, The World's Monetary Prob¬ 
lems , London, 1921; p. 52. 

8. J. V. Nash, “The Golden Dam to the Stream of Prosperity,” 
Dearborn Independent , August 19, 1922. 

9. New York Times, July 16, 1922; section 7. 

10. Dearborn Independent, March 11, 1922. Concerning the results 
of keeping interest rates down by a policy that pushes prices up, 
see E. W. Kemmerer, High Prices and Deflation , Princeton, 1920: 
chap. 1. 

Chapter IX 

1. Dearborn Independent, March 25, 1922. There is a sound discus- 

, sion of the problem of stabilizing foreign exchange by B. M. An¬ 
derson, Jr., in The Chase Economic Bulletin, New York, January 
12, 1922; vol. 11, No. 1. 

2. Gustav Cassel, Money and Foreign Exchange after 1914, London, 
1922; p. 107. 

3. Dearborn Independent, March 25, 1922. 

4. By “stabilization of purchasing power,” we mean here, as through¬ 
out this volume, approximate stabilization. Absolute stability, 
as we have pointed out in earlier chapters, is not attainable in a 
world in which nothing is absolutely stable upon which a unit of 
value might be based. (See page 122, above.) 

5. Figure 7 is a map of Europe, prepared by the National Industrial 
Conference Board, to show the values of European currencies, 
based on New York exchange, September 1-15, 1922. The figures 
are from the Federal Reserve Board. 


NOTES TO CHAPTER X 


383 

6. In spite of all that we have said about the injurious effects of infla- 
tion, we must admit the necessity of a qualification to Professor 
Alfred Marshall’s statement that “an increase in the amount of 
money in a country does not increase the total services which it 
performs.” {Money, Credit and Currency, London, 1923; p. 49.) 
When, for any reason, there is a downward movement of general 
prices and a consequent tendency to business depression and in¬ 
creased unemployment, any increase in the total volume of money 
in circulation is likely to increase the total services which it per¬ 
forms. In subsequent chapters, we shall pursue this subject further 
and reach the conclusion that when such conditions prevail in any 
country, an increase in the amount of money in circulation which 
goes directly into the hands of consumers is sure to move an in¬ 
creased volume of goods into consumption, stimulate production, 
increase employment and, therefore, for the time being increase 
the total services which money performs. 

Chapter X 

1. Irving Fisher, The Making of Index Numbers, Poliak Publication, 
Number 1, Newton, Massachusetts, 1922. 

2. This is the equation of exchange upon which Professor Fisher 
bases his book, The Purchasing Power of Money. That book con¬ 
tains a more extensive exposition of the equation of exchange than 
we have presented. 

3. Professor Fisher expresses the goods side of the equation of ex¬ 
change as PT, allowing P to stand for the level of prices and T for 
the volume of goods sold. The equation then reads: MV = PT. 

Many have raised the objection that the expression of %pq as 
PQ is inexact and fanciful. It would be grossly so if P were taken 
as an average of prices and Q as a sum of quantities; but the 
“units” of Q are not tons, yards, bushels, and so forth, but “dol¬ 
lars’ worth as of a base year.” Wdth the new refinement of index 
number methods, in Dr. Fisher’s The Making of Index Numbers, 
PT becomes charged with an amazingly precise meaning, the 
fringe of possible doubt being less than a tenth of one per cent. 

MV = 2 P q = P (QS p o q 0 ) = PT 

That is to say, P is the index number of prices while T is the prod¬ 
uct of the index number of quantities ( Q ) times the value sum 
C%p 0 q 0 ) in the base year used for reference. P and Q have no mean¬ 
ing for one year alone. They imply more than one year, since they 
are index numbers. Thus, the equation of exchange for 1922 tells 
us that the money in 1922 (M) times its velocity (F) equals the 
index number of prices of 1922 relatively to some other year, say 


384 


MONEY 


1913, times the index number of quantities exchanged (Q) rela¬ 
tively to the same base, 1913, times the total value exchanged 
in the base year (%p 0 q 0 ). Since we are usually more interested in 
the price-level ( P ) than the trade level (Q), we lump the last two 
of the three factors together and call it T. 

4. Simon Newcomb, Principles of Political Economy, New York, 
1885; p. 346. 

5. This point is well considered in Frank H. Knight’s Risk, Uncer¬ 
tainty and Profit, Boston, 1921; chap. 1. 

6. Oswald St. Clair, The Physiology of Credit and of Money , London, 
1921; p. 45. 

7. Ibid., p. 55. 

8. Simon Newcomb, Principles of Political Economy, New York, 
1885; p. 332. 

“The total value of an inconvertible paper currency, therefore, 
cannot be increased by increasing its quantity: an increase in its 
quantity, which seems likely to be repeated, will lower the value of each 
unit more than in proportion to the increase .” (Alfred Marshall, 
Money, Credit and Commerce, London, 1923; p. 48.) 

9. Figure 12 is on page 243. 

10. This matter is discussed in Chapter XVIII. 

11. “ It is not uncommon in Austria and other countries of central and 
eastern Europe for a commodity to pass through the hands 
of fifteen or twenty speculative middlemen — each taking toll 
through price advances — before it reaches the final consumer. 
Such business activity yields monetary profits, but it does not 
increase production. On the contrary, it demoralizes industry.’’ 
(Bass and Moulton, America and the Balance Sheet of Europe, 
New York, 1921; p. 125.) 

12. These questions are discussed in “The Circuit Flow of Money,” 
American Economic Review, September, 1922, by William Trufant 
Foster. The substance of this paper is included in Chapter XVIII, 
below. 

Professor Alfred Marshall, in Money, Credit and Commerce (Lon¬ 
don, 1923; p. 48), says: “The other things, that must remain equal 
for the purposes of this statement, include (a) the population; (b) 
the amount of business transacted per head of the population; (c) 
the percentage of that business which is effected directly by 
money: and (d) the efficiency (or average rapidity of circulation) 
of money. Only if these conditions are reckoned in, can the doc¬ 
trine come under investigation: and if they are reckoned in the 
doctrine is almost a truism.” (In this quotation the term “ money ” 
appears to be synonymous with our term “currency,” and that is 
the sense in which the term “money” is employed throughout this 


NOTES TO CHAPTER X 


385 

note.) This enumeration of the other things that must remain 
equal is not entirely satisfactory. In terms of the equation of 
exchange (MV = PT) we may note that if (a), (b) and (c) are 
all constant, T is constant; but T may remain constant and P 
may remain constant, under numerous conditions other than 
those enumerated above. In the first place, it is not necessary 
that the population should remain equal. A given amount of 
money spent for a given purpose, within a given period of time, by 
a given number of people, has the same effect upon the price-level 
as when spent by a smaller or larger number of people. In the 
second place, “the amount of business transacted per head of 
population” need not remain the same. Changes in other factors 
may offset the influence on prices of changes in the amount of 
business transacted per head of population. We must, however, 
make various inquiries concerning the nature of the business trans¬ 
acted, including the crucial question whether there are changes in 
the proportions of the total transactions which have to do with 
production, consumption, and speculation. In the third place, it 
is not necessary that “the percentage of that business which is 
effected directly by money” should remain equal: a change in that 
factor may be offset by a change in other factors. On the other 
hand, that factor might remain the same, yet there might be a 
change in prices due to a change in the proportions of the various 
kinds of business that are transacted without the use of money. 
(See pages 163-167.) In the fourth place, the efficiency of money 
as a whole need not remain the same. And even if it did remain the 
same, we should still have to ask whether there were changes in the 
relative rapidity of circulation of money used to produce goods 
and money used to buy consumers’ goods (see Chap. XVIII); and 
whether there were changes in the relation of each of these items to 
the rapidity of circulation of money used in speculation. (See 
Chap. XIV.) Finally, we must consider changes in the volume and 
velocity of bank credit and in the nature of the transactions 
effected by means of bank credit. Evidently, then, before we can 
look upon the “quantity doctrine” as almost a truism, we must 
take into account various “other factors” not enumerated by Pro¬ 
fessor Marshall. It appears that much of the current, confusing 
controversy over the “quantity doctrine” is due to the fact that 
most writers have based their discussions upon an inadequate 
analysis of those other factors that must remain equal. 

Statistics for Figure 8 were provided by the Federal Reserve Bank, 
New York City. Other countries furnish many other illustrations 
of the close correlation between changes in prices and in volume 
of money. See, for example, Figure 1, page 59, in Gustav Cassel’s 


386 


MONEY 


Money and Foreign Exchange after 1914 , London, 1922. This figure 
shows the marked correspondence between note circulation in 
Sweden, 1914 to 1920, and prices. See, Report on Business Con¬ 
ditions , Second Federal Reserve District, New York, March 20, 
1920; May 31, 1920. 

14. The New York Times says, editorially, that “the position of those 
theorists who ascribe the whole of every rise or fall in prices to 
expansion or contraction of the currency has been made untenable 
by the facts.” If there are any such theorists, they were discredited 
long before the War. But the editorial proceeds into debatable 
ground, for it implies the argument, now frequently heard, that 
price changes are always the cause of changes in the volume of 
money. 

One reason why official statistics for the past decade do not 
show an exact correlation between changes in the volume of money 
in circulation and changes in the price-level is because changes in 
the volume of money in circulation in each country have not been 
measured with accuracy. We know in a general way that during 
the War currency was exported in large quantities, but we have 
little statistical data. How much of the currency of the United 
States went to Europe? How much to South America and to 
Central America? How much of the currency of Germany came 
to the United States? Due recognition of the importance of these 
questions might lead the governments of the world to cooperate 
officially in obtaining more dependable estimates than we now 
have of the international movements of currencies. 

Chapter XI 

1. George W. Gough, Wealth and Work, London, 1920; p. 248. 

The investigations of the building industry by the Lockwood 
Committee of New York and the Daly Committee of Chicago 
show to what extent the consumers’ desires concerning volume, 
quality, and price are sometimes frustrated when groups of pro¬ 
ducers get together to eliminate competition. 

2. C. H. Douglas, The Control and Distribution of Production , Lon¬ 
don, 1922; p. 19. 

3. There is an effective use of the dollar-vote analogy in Thomas N. 
Carver’s Essays in Social Justice , Cambridge, 1915; chap. v. 

4. See publications of the Proportional Representation League, 1417 
Locust Street, Philadelphia. 

5. C. H. Douglas, Credit Power and Democracy , London, 1921; p. 16. 

Except in the case of monopoly, it is not in the interests of the 
individual producer to attempt to keep up prices by restricting his 
output. For that reason, we cannot agree with Frederick L. Acker- 


NOTES TO CHAPTER XI 


387 

man that “the central interest of all who engage in the production 
of goods and services is unavoidably in the maintenance of supply 
at a point appreciably short of the communities’ needs, or more 
precisely, short of the communities’ effective demand.” ( The 
Journal of the American Institute of Architects, January, 1923; 
p. 27.) “So productive is the machine process,” he declares, “that 
it cannot possibly be allowed to run at anything like its capacity. 
For to allow it so to run under distribution regulated by the price 
system would be to bring privation and hardship not only to the 
producers, but to the community as a whole.” This is the central 
theme of a large modern school of economics. Their writings should 
stimulate thought in the right direction; but they err in conclud¬ 
ing that the conditions they rightly condemn are due to the fact 
. that goods are produced for profit and distributed by the price 
system. 

6. See pages 219-227. 

7. Many critics of the existing economic order insist that production 
schedules should be controlled by consumers. Says Major Douglas 
{Living Age, January 19, 1919): “So far from the necessity of this 
country and the world being an orgy of unlimited production, the 
first need is for a revision of material necessities combined with 
sound scientific efforts to produce to a program framed to meet the 
extended demands not artificially stimulated but individualistic 
in origin wherever possible.” The author appears to miss the 
point. No other enterprise of human society is now, in fact, so 
largely individualistic in origin as commercial production. 

Sidney A. Reeve, on the other hand, has written a book of eight 
hundred pages {Modern Economic Tendencies, New York, 1921) 
to prove that there is no way whereby the people can direct pro¬ 
duction to the satisfaction of their desires except through an or¬ 
ganization of consumers. He ignores the fact that production is 
to-day almost exclusively directed by the joint action of all con¬ 
sumers individually expressing their desires. Nor does it seem to 
occur to him that the only organization of all the consumers in this 
country is the Federal Government, and that he is in fact arguing 
for the control of all production by politicians, a method that 
must inevitably fail to satisfy the wishes of the people. “Under a 
national factory system,” he says, “each citizen will be paid what 
the consumer thinks he is worth, as his efforts are appraised auto¬ 
matically by the consumer’s selection at the shop-counter. The 
great majority will then earn far more than now, in purchasing 
power, because they produce what the people really want” 
(p. 767). Since the author overlooks the fact that his “Ultimate 
Consumers,” who are to control production in his ideal society, 


388 


MONEY 


are really “the State,” he also overlooks the fact that the problem 
of organizing consumers for the direction of industry — the details 
of which he avoids throughout the volume — is nothing but the 
old problem of maintaining the efficiency of politically controlled 
enterprises. 

Bank credit, also, according to Major Douglas (Credit Power 
arid Democracy ) should be controlled by the people; but that means, 
necessarily, political control. Under the present system, the dis¬ 
tributors of bank credit go out of business unless they succeed, for 
the most part, in giving the people what they want. Politicians 
could produce goods and services, regardless of the wishes of the 
people, and continue producing until their terms of office expired, 
and even then often escape responsibility for their acts. In any 
event, it would be other people’s money that they had wasted. 

In Economic Democracy , New York, 1920; p. 140, Major Doug¬ 
las denounces “the capitalistic system of price-fixing” and urges 
“the fixing of prices on the broad principles of use-value, by the 
community as a whole, operating by the most flexible represen¬ 
tation possible.” But the author fails to offer any system of price¬ 
fixing that would be as flexible a representation of the wishes of 
the whole community as the system that now prevails. 

The New Republic (editorial: June 2, 1920; p. 4) also misdirects 
its attacks upon the economic order when it says: “The oppor¬ 
tunities for making profits were prodigious, but the profits were 
to be made not so much by increasing production as by manipulat¬ 
ing prices. . . . Under such circumstances, the condemnation of 
profiteering is equivalent to a condemnation of the mechanism of 
production, which derives its motive power from profits. The only 
way to render that denunciation effective is to seek reorganization 
of industry which shall abandon profits as its source of energy.” 
The root of the trouble is not in the fact that goods are produced 
for sale at a profit, nor in the control of prices by the individual 
producer, but in fluctuating price-levels mainly due to monetary 
causes. 

Major Douglas has rendered a timely service by urging the study 
of the causes that prevent consumers from obtaining enough money 
to buy, at current prices, the commodities that are produced. As 
will appear in later chapters, Major Douglas seems to us to be one 
of the few writers who have looked in the right direction for the 
major cause of economic troubles. But his analysis of the causes 
of deficiency in consumers’ purchasing power seems to us faulty; 
and his proposed remedies, as we understand them, seem imprac¬ 
tical, and even if practical, inadequate. See note 4 to Chapter 
XVI, and note 15 to Chapter XVII. See, also, Chapter XX, below. 


NOTES TO CHAPTER XII 


389 

8. Senate Bill 2604, 67th Congress, 1st Session; introduced by Mr. 
Ladd, October 14, 1921. See, also, Gustav Cassel, Money and 
Foreign Exchange after IQ14 , London, 1922; pp. 19-25. 

9. Gustav Cassel, The World's Monetary Problems , London, 1921. 

Dr. H. Potthoff, of Munich, in his Arbeitsrecht (October 30, 
1920), advocates collective agreements between employers and 
employees which shall not only fix wages for a long period, but at 
the same time fix the prices of the chief necessities of life. Under 
this plan employers not only guarantee the workers a fixed nom¬ 
inal wage, but a fixed real wage, by assuming the risk of future 
changes in prices. The Korrespondenzblatt , the journal of the 
German Federation of Labor, opposes the plan on the ground that 
it would be unsatisfactory to the workers for the same reason that 
the war-time price-fixing and rationing schemes were unsatis¬ 
factory. As a matter of fact, the plan would not trouble the 
workers for more than a few months. Regardless of collective 
agreements, it would break down just as soon as there were not 
enough goods produced to go around at the stabilized prices. (See 
Monthly Labor Review , May, 1921; p. Q2.) 

Chapter XII 

1. See Chapter III. 

2. F. O. Watts, President of the First National Bank in St. Louis, 
and Chairman of the American Financial Delegation to the Inter¬ 
national Chamber of Commerce Meeting at London, June, 1921. 
Commercial and Financial Chronicle, October 29, 1921; p. 93. 

3. Bilgram and Levy, The Cause of Business Depressions , Philadel¬ 
phia, 1914; p. 53. 

4. Lettice Fisher, Getting and Spending, London, 1922; p. 162. 

5. Sir Lancelot Hare, A Study of Exchange, London, 1921; p. 15. 

6. George W. Gough, Wealth and Work, London, 1921; p. 126. 

7 and 8. Further references are needless. The idea pervades economic 
writings that supply and demand are the same thing looked at 
from different standpoints and must be equal. The error is due 
directly to the insistence that modern trade is merely refined bar¬ 
ter and to the consequent overlooking of the changes introduced 
when demand is expressed, not in goods, but in money. 

9. See, also, George E. Roberts, in Review of Reviews , November, 
1921; p. 509. 

10. Oswald St. Clair, Physiology of Credit and of Money , London, 1921; 
p. 106. 

11. Percy and Albert Wallis, Prices and Wages, London, 1921; 
PP- 393 ; 396 . 

12. J. Laurence Laughlin, Principles of Money , New York, 1903; p. 74. 


MONEY 


390 

13. W. P. G. Harding, Address at Charlotte, North Carolina, Septem¬ 
ber 22, 1921. 

In the Annalist (New York) December 18, 1922; p. 660, Dr. 
R. Escourt says: ‘‘Federal Reserve notes are not accommodation 
bills but first class bills of exchange, fully represented by wealth 
produced and ready for distribution and consumption.” Here, 
in the words “fully represented,” we seem to have the same mis¬ 
leading assumption that we have observed in the other quota¬ 
tions. 

Francis H. Sisson, vice-president of the Guaranty Trust Com¬ 
pany of New York, in an address before the Pittsburgh Chapter 
of the American Institute of Banking, December 7, 1920, said: 
“Neither the banks nor the Government can create credit. 
Credit is the product of enterprise and operations in commerce, 
and is limited and defined by the nature of such operations. 
That Mr. Sisson does not mean that the expansion and contraction 
of bank credit is strictly limited by the nature of the commercial 
operations seems evident from remarks in the same address. He 
says, for example, “the banks must necessarily exercise restraint 
upon the expanding volume of credit”; and he speaks of “condi¬ 
tions which have made necessary a bank policy intended to check 
the expansion of bank credits.” If, as is usually assumed, inflation 
cannot result from loans made against commodities, in the ordinary 
course of business, banks would not need to exercise restraint upon 
the expanding volume of bank credit. 

Concerning bank loans and the values behind them, see 
H. Parker Willis and George W. Edwards, Banking and Business, 
New York, 1922; pp. 493-495. 

H. C. Cutting, in The Strangle Hold , Chicago, 1921; p. 285, 
proposes control of bank credit by the public, so that “credit 
could be extended to any length as far as both time and amount 
are concerned. ... There would be no control except the demands 
of business.” 

14. W. Stanley Jevons, Money and the Mechanism of Exchange, New 
York, 1895; p. 1. 

Chapter XIII 

1. Walter W. Stewart, “An Index Number of Production,” American 
Economic Review, March, 1921. 

Monthly Review of Credit and Business Conditions, by the Fed¬ 
eral Reserve Agent, New York, October 30, 1920; p. 11. 

Edmund E. Day, “ The Volume of Production of Basic Materials 
in the United States, 1909-1921,” Harvard University Review of 
Economic Statistics , July, 1922. 


NOTES TO CHAPTER XIV 


39i 

Walter R. Ingalls, Wealth and Income of the American People , 
York, Pennsylvania, 1922; p. 281. 

See, also, Income in the United States, Its Amount and Distribu¬ 
tion, igog-igig. Publication Number 2 of the National Bureau of 
Economic Research, Incorporated, New York, 1922. 

2. O. M. W. Sprague, “Discount Policy of the Federal Reserve 
Banks,” American Economic Review , March, 1921; p. 16. 

Warren M. Persons, in The Basis of Credit Expansion under the 
Federal Reserve System (The Review of Economic Statistics , Prelim¬ 
inary Volume 11, Cambridge, 1920; p. 21), estimates the theoretical 
range of credit as ten to twenty-five times the amount of gold in 
the reserves. 

3. Figure 11 is from the Report on Business Conditions of the Federal 
Reserve Agent at New York, March 20, 1920. 

Professor Kemmerer says: “We find that for those six years 
[1913 to 1919] the physical volume of business increased approxi¬ 
mately 9.6 per cent, the monetary circulation 71 per cent, and 
bank deposits 120 per cent.” (E. W. Kemmerer, High Prices and 
Deflation, Princeton, 1920; p. 29.) 

4. Charles Gide, Principles of Political Economy, Boston, 1904; p. 212. 

5. W. F. Spalding, Functions of Money, London, 1921; p. 19. 

Chapter XIV 

1. The usual discussion of the good and evil effects of speculation is 
found in various textbooks. See, for example, F. W. Taussig, 
Principles of Economics, New York, 1916; vol. 1, chap. xi. 

2. See the Report on Business Conditions, from the Federal Reserve 
Agent at New York, to the Federal Reserve Board, January 20, 
1920. 

3. These characteristics of money are analyzed in Chapter XII. 

4. In Bank Credit and Business Cycles (Number 5 of the Poliak Publi¬ 
cations), O. M. W. Sprague discusses methods of curbing the ex¬ 
pansion of bank credit, as prices advance. 

5. We cannot agree with Major Douglas that “the banks, through 
their control of credit facilities, hold the volume of production at 
all times in the hollow of their hands.” (C. H. Douglas, The 
Control and Distribution of Production, London, 1922; p. 21.) 

This error underlies much of the current literature of reform. 
In The New Economics, for example, we read: “The quantity and 
class of goods to be produced, and their distribution when com¬ 
pleted, the community as a whole has no power of deciding: in this, 
as in all other matters, it is completely in the hands of the banking 
interests.” (Marten Cumberland and Raymond Harrison, The 
New Economics , London, 1922; pp. 51-52.) 


MONEY ! 


392 

6. Concerning the merits of the Federal Reserve System, see: Harold 
L. Reed, The Development of Federal Reserve Policy , Boston, 1922. 
Robert L. Owen, The Federal Reserve Act, New York, 1919* H. 
Parker Willis, “The Federal Reserve System,” Political Science 
Quarterly , December, 1922. 

Chapter XV 

1. It is exceedingly difficult to draw a hard-and-fast line between 
producers’ goods and consumers’ goods. What are railroad ties, 
for example, and street pavements? What is wheat bread that a 
farmer consumes for his own pleasure, but also in order that he 
may have strength to plant more wheat? Fortunately, the rough 
distinction that we have made is sufficient for all the purposes of 
this volume. 

2. J. A. Hobson, Work and Wealth, New York, 1919; p. 190. 

3. George W. Gough, Wealth and Work, London, 1921; p. 161. 

4. Walter R. Ingalls, Wealth and Income of the American People , 
York, Pennsylvania, 1922. 

5. Those who admit all that we have said about the necessity of con¬ 
tinued accumulations of capital facilities, may still ask whether 
there is not danger of excessive accumulations. J. A. Hobson goes 
so far as to ascribe periodic business depressions wholly to “a 
normal tendency to apply to the production of capital-goods a pro¬ 
portion of the aggregate productive power that exceeds the propor¬ 
tion needed, in accordance with existing arts of industry, to supply 
the consumptive-goods which are purchased and consumed.” 
{Economics of Unemployment, London, 1922; p. 147.) This ques¬ 
tion is considered in Chapter XX, below. 

Chapter XVI 

1. As this is the usual statement, it is familiar to all readers of current 
economic literature. 

2. Pages 220-221. 

3. Current Affairs , Boston, March, 1921; p. 4. 

4. Concerning the time-factor in production and the deficiency of 
purchasing power that develops as business expands, Hudson B. 
Hastings, of the Poliak Foundation, has made studies that have 
confirmed the authors of this volume in their impression of the 
importance of these factors. While he must not be held responsible 
for the views here expressed by the authors, his help has been in¬ 
valuable. The rigorous analyses which he has just completed 
(March, 1923) answer with precision some of the questions we have 
raised. His study on Costs and Profits (Number 3 of the Poliak 
Publications) enables us to supplant surmises concerning certain 


NOTES TO CHAPTER XVII 


393 

major factors of business fluctuations with conclusions from which 
there is no escape. 

Chapter XVII 

1. Thomas YV. Lamont, "The American Banker's Responsibility,” 
Journal of the American Bankers Association , November, 1922; 
p. 261. 

2. See pages 35-40. 

3. See pages 163-167. 

4. F. Lavington, The Trade Cycle , London, 1922; p. 30. 

5. M. C. Rorty, Notes on Current Economic Problems, No. III. Pub¬ 
lication of American Telephone and Telegraph Company; 1921; 
P- 5 - 

6. John H. Van Deventer, "Unemployment a Cause, Not an 
Effect of Industrial Depression,” Industrial Management, Octo¬ 
ber, 1921. 

7. C. H. Northcott, "Unemployment Relief Measures in Great 
Britain,” Political Science Quarterly, September, 1921; p. 420. 

8. Figure 13, based on statistics furnished by the Federal Reserve 
Bank of New York, compares retail sales with wholesale sales, 
1919-1921. The statistics are for sales of representative depart¬ 
ment stores in the New York district, compared with a weighted 
index of sales of wholesale houses in the district; also for sales of 
chain grocery and drug stores having headquarters in this district 
compared with the sales of wholesale grocery and drug concerns 
in the same district. (See, also, Monthly Review of Credit and Busi¬ 
ness Conditions, by the Federal Reserve Agent, New York, August 
1, 1921; pp. 9-10.) 

Studies by the Department of Industrial Statistics of the Federal 
Reserve Bank of Boston, not yet published, show an actual falling- 
off in the physical volume of trade of five leading department 
stores of Boston; but the figures give us no indication whether 
the slump was due to lack of purchasing power or a "Buyers’ 
Strike.” 

9. Monthly Review of Credit and Business Conditions, by the Federal 
Reserve Agent at the Federal Reserve Bank, New York, June 
1, 1921. 

10. E. M. Herr, New York Evening Post, November 3, 1921. 

"Building was reduced to a minimum, road construction was 
stopped, furnaces from one end of the country to the other were 
banked, unemployment to a frightful extent ensued; and all this 
for no lack of credit facilities, but for lack of markets in which to 
sell the products of farm and mill and factory.” (Senator Glass, 
before the United States Senate, January 16-17, 1922.) 


394 


MONEY 


Chapter XVIII 

1. George W. Gough, Wealth and Work , London, 1920; p. 138. 

2. See Chapter X, above; pp. 171-175. 

3. Figure 14 is from the Federal Reserve Bank of New York. 

The annual rate of turnover is obtained by subtracting Time 
Deposits and Government Withdrawals from the gross Debits to 
Individual Accounts, thereby securing revised figures for the debits. 
These revised debits are shown weekly, but are later grouped into 
a monthly total. This total is divided by the number of working 
days in a given month and the resulting figures give average daily 
individual debits. This latter figure is then multiplied by the num¬ 
ber of working days in the year, and that result, divided by the 
average daily net demand deposits, yields the annual rate of turn¬ 
over. 

4. Money in circulation, as we use the term, is defined on page 19, 
above. 

5. M. C. Rorty, Notes on Production , Publication of the American 
Telephone and Telegraph Company. See, also, M. C. Rorty, Some 
Problems in Current Economics , New York, 1922; p. 63. 

6. Irving Fisher, Purchasing Power of Money , New York, 1920. See, 
also, Income in the United States , National Bureau of Economic 
Research, 1921. 

7. Simon Newcomb, in his Principles of Political Economy , Book iv, 
chap. 11, deals with an equation of exchange, under the name of 
“the equation of societary circulation.” In Book iv, chap, iv, 
sec. 15, on “Changes in Rapidity of Circulation,” he mentions two 
of the factors that we have enumerated, namely, the prospect of 
changes in price, and changes in the amount of money paid as 
wages. He says: “If in a manufacturing establishment an unex¬ 
pected disagreement occurs between the employer and the opera¬ 
tives, the money which the former received in the course of busi¬ 
ness no longer goes to the payment of the latter, and remains for 
a longer period on their hands than it would otherwise have done. 
Thus every strike on the part of laborers tends to diminish the 
rapidity of circulation.” This quotation illustrates the importance 
of distinguishing between rapidity of circulation and rapidity of 
the circuit flow. It is the circuit flow, and not necessarily the cir¬ 
culation of money in general, that is retarded when a smaller pro¬ 
portion of the money in circulation is paid as wages. When a 
manufacturer curtails production, and therefore needs less money 
for the payment of wages, he may immediately pay off bank loans, 
thus reducing the volume of money in circulation. He thereby 
retards the circuit flow of money, but not the velocity of money. 

8. A more detailed study of some of the phases of this subject will be 


NOTES TO CHAPTER XVIII 


395 


found in a paper by Hudson B. Hastings, of the Poliak Foundation 
C American Economic Review , June, 1923), on “The Circuit Veloc¬ 
ity of Money.” This paper is an extension of Chapter XVIII of 
this volume. 

Professor Hastings comes to the following conclusions: 

There are and always have been numerous changes going on in 
the business world whose influence is either to increase or decrease 
the circuit velocity of money. 

These changes are brought about by those who neither know, 
nor see any reason why they should care to know, what will be the 
influence of these changes on C. 

No intelligent attempt is made by individuals, business con¬ 
cerns or government agencies to control or modify the influence of 
the various factors that affect C. 

By the laws of chance alone, C will not remain constant. 

Relatively few of the factors that effect a change in C are offset 
by a change in the volume of money which is produced at the same 
t time and from the same cause. 

The major net changes which these factors bring about in C tend 
to produce corresponding changes in the average daily amount of 
money spent for goods in consumption; and if there are no changes 
in the number of units of goods consumed, these changes in the 
general price-level of goods are disclosed by the index equation of 
exchange ( M\C\ = P1T1). 

The retail price-level of tangible consumers’ goods, which is of 
primary importance to the business world and to the consuming 
public, is a function of C and not of V; and there are many factors, 
particularly those of a secular nature, which do not have the same 
effect on C as on V. 

Therefore, changes in the general price-level of new consumers’ 
goods can be much more readily explained by the use of the index 
equation of exchange than by the use of the general equation of 
exchange (MV -f M'V' = PT). 

. The J. Walter Thompson Company, of New York City, is to be 
commended for its efforts to stimulate interest in the measurement 
of the flow of money into consumers’ hands. The Company offered 
a prize for studies, submitted before September 30, 1923, of “A 
Statistical Index of the Purchasing Power of Consumers in the 
United States.” We quote from the announcement: 

“It is the belief of the donors that an accurate knowledge of 
markets for products is fundamental in the formulation of business 
policies, and that the clarifying of methods and the development of 
a trustworthy technique in.measuring the buying capacity of con¬ 
sumers living in different parts of the country, in different and 


396 


MONEY 


varying types of communities, and under divergent conditions of 
prosperity or depression, has become an important part of the 
process of making intelligent market plans. 

“Studies have been made in the past in the distribution of 
population, as well as in incomes. Thus recent studies published 
by the National Bureau of Economic Research on ‘ Income in the 
United States’ offer a summary of incomes in this country. Very 
little attempt has been made, however, to translate incomes into 
terms of purchasing power, which are, of course, the terms in 
which they gain their practical significance. Moreover, even in 
the studies of incomes which have been made, there has been only 
partial subdivision of the results by sections of the country, sizes 
of towns, or types of communities, or to indicate variations due 
to changes in general economic conditions. 

“Work has also been done in the matter of individual or house¬ 
hold budgets. Various organizations have compiled statistical 
information concerning the expenditures of individual families of 
different types and classes. Yet here also the work has been neither 
comprehensive nor coordinated. 

“In order that contestants may realize how unrestricted the 
competition is, we mention the following as topics which would be 
included in the general subject: margins of savings in typical 
family budgets; classification of expenditures in typical budgets 
by necessities, semi-luxuries, and luxuries; incomes classified by 
occupations, sections of the country, sizes of towns, types of 
communities, conditions of prosperity or depression; methods of 
determining potential demand for commodities of various types. 
The contestant may discuss either the material of a particular 
problem or a method of securing such material or both. 

“The subject, however, is to be treated with special relation to 
the buying capacity of the ultimate consumer. In order to limit 
the scope of the work to be done, therefore, the demand for con¬ 
sumers’ goods alone should be covered, eliminating any discussion 
of the demand for raw materials or other types of producers’ goods 
which go into the making of finished products.” 

This announcement emphasizes the necessity of measurements 
of the buying capacity of consumers as a basis for intelligent mar¬ 
ket plans. Such measurements, in our view of the subject, have a 
much wider significance: they are essential to an understanding 
of all the major problems of economics. Yet, as we have said in 
Chapter XVIII, most of this region is virgin ground. 

Chapter XIX 

I. Oswald St. Clair, The Physiology of Credit and of Money , London, 
1921; p. 72. 


NOTES TO CHAPTER XX 


397 


2 . Typical of the demands for more money are the following: 

“Money is scarce and dear, because limited in quantity and 
monopolized by one private business.” (H. L. Loucks, The Great 
Conspiracy , Watertown, S.D., 1916; p. 35.) 

“Wealth must slow down to pass through the narrower gates of 
money, because there is more wealth than there is money to move 
it.” {Dearborn Independent , January 28, 1922.) 

“The business body is sluggish on account of contracted credit 
and currency.” (Official publication of the Farmers’ Union of 
Kansas, March 16, 1922.) 

“The whole circle of labor, production and use is stopped 
because of the insufficiency of money.” ( Dearborn Independent, 
January 21, 1922.) 

“Money has been banned as currency by fiat of the workers’ 
soviet, while here at home it has been banned by the bankers’ 
soviet.” {Labor, January 29, 1921.) 

In Money Problems (London, 1920) Arthur Kitson says: “The 
average business man is beginning to realize that what the banker 
calls ‘accommodation,’ and grants to him with the air of an auto¬ 
crat bestowing favours upon a subject, is something which already 
belongs to him, and to other members of his class collectively, and 
to the use of which he has a moral right. He fails to see why this 
should not be made a legal right.” Obviously, if the average busi¬ 
ness man has a legal right to all the credit he wants, there is no 
limit whatever to inflation. 

Chapter XX 

1. The best summary of theories of business cycles is in Wesley Clair 
Mitchell’s Business Cycles, Berkeley, California, 1913. Another is 
in J. Lescure’s, Des crises generates et periodiques de surproduction, 
Paris, 1907. A recent summary is in Volume IV of The Review of 
Economic Statistics , Cambridge, Mass., October, 1922: “Secular 
Trend and Business Cycles: a Classification of Theories,” by J. R. 
Commons, H. L. McCracken, and W. E. Zeuch. 

2. R. E. May, Das Grundgesetz der Wirtschaftskrisen, Berlin, 1902. 

3. A. Aftalion, Essai d'une theorie des crises generates et periodiques, 
Paris, 1909. 

4. M. Bouniatian, Studien zur Theorie und Geschichte der Wirtschafts¬ 
krisen, Munich, 1908. 

5. See articles in Schmoller’s Jahrbuch filr Gesetzgebung, 1902. 

6. Jean Lescure, Des crises generates et periodiques de sur production, 
Paris, 1907. 

7. J. A. Hobson, The Economics of Unemployment , London, 1922; 
p. 50. 


398 MONEY 

8. C. H. Douglas, “The Delusion of Super-production,” Living Age , 
January 18, 1919; p. 180. 

9. That real wages of labor increased for many decades, under a 
system of production for sale at a profit, is true whatever the facts 
may be for the last quarter of a century. (See Paul H. Douglas 
and Frances Lamberson, “The Movement of Real Wages, 1890- 
1918,” American Economic Review , September, 1921; p. 409.) 

It is important to keep in mind the distinction between total 
wages and wage rates. Concerning the extent to which wage rates 
lag behind the cost of living, see W. T. Layton, An Introduction to 
the Study of Prices , London, 1920; pp. 136-140. 

For a chart by G. H. Wood showing the course of money wages, 
real wages, retail prices, and unemployment, 1850 to 1910, see 
W. T. Layton, An Introduction to the Study of Prices , London, 
1920; p. 185. 

The following table, prepared by Mr. Bowley, shows the course 
of money wages, prices, and real wages during the nineteenth 
century. (From the article on “Wages” in Palgrave’s Dictionary 
of Political Economy.) 


Periods 

Nominal Wages 

Prices 

Real Wages 

1790-1810 

Rising fast 

Rising very fast 

Falling slowly 

1810-1830 

Falling 

Falling fast 

Rising slowly 

1830-1852 

Nearly stationary 

Falling slowly 

Rising slowly 

1852-1870 

Rising fast 

Rising 

Rising considerably 

1870-1873 

Rising very fast 

Rising fast 

Rising fast 

1873-1879 

Falling fast 

Falling fast 

Nearly stationary 

1879-1887 

Nearly stationary 

Falling 

Rising 

1887-1892 

Rising 

Rising and falling 

Rising 

1892-1897 

Nearly stationary 

Falling 

Rising 

1897-1900 

Rising fast 

Rising 

Rising 

1900-1904 

Falling a little 

Falling and rising 

Stationary 


The prices are based on the price index numbers of Jevons and of the Economist. 


10. C. H. Douglas, “The Delusion of Super-production,” Living Age , 
January 18, 1919; p. 180. 

11. C. H. Douglas, The Control and Distribution of Production. 

Economic Democracy. 

Credit Power and Democracy. 

The Douglas Theory: A Reply to Mr. J. A. Hobson. 
W. Allen Young, Dividends for All: Being an Explanation of the 

Douglas Scheme. 

Hilderic Cousens, A New Policy for Labour . 














NOTES TO CHAPTER XXI 


399 

These books are all published by Cecil Palmer, Bloomsbury Street, 
London, W. C.T. 

12. C. H. Douglas, Economic Democracy , New York, 1920; pp. 66, 67. 

13. J. A. Hobson, The Economics of Unemployment , London, 1922; p. 

147. 

14. Ibid., pp. 42, 67, 80, 119. 

15. Ibid., p. 81. 

16. See page 316, above. 

17. J. A. Hobson, The Economics of Unemployment, Chapter V. 

18. See C. H. Douglas, The Douglas Theory: A Reply to Mr. J. A. Hob¬ 
son, and Mr. Hobson’s criticism of the Douglas Theory, in Chapter 
VIII of The Economics of Unemployment. 

19. Hudson B. Hastings, in Costs and Profits, Number 3 of the Poliak 
Publications, presents an extensive analysis of the effects of costs 
and profits on the state of business activity. What we have said 
toward the close of Chapter XVII embodies some of the main con¬ 
clusions of that study and, indeed, is not altogether clear, except in 
the light of that study. His book offers a new analysis of the causes 
of business depressions. The analysis is based on an attempt to 
measure the total value of tangible and intangible goods produced 
for sale in relation to the total purchasing power available for the 
purchase of such goods. By an accounting method, the conclusion 
is reached that, because of the ways in which some items of cost, 
intercorporate income, and particularly profits are handled by 
typical business concerns during a period of business activity, the 
value, at the current retail price-level, of goods produced far ex¬ 
ceeds the flow of purchasing power from permanent sources. In 
other words, recurring periods of business depression are the cer¬ 
tain result of present financial and business policies. The analysis 
shows that a further cause of business crises and depressions is the 
overdevelopment of concerns producing tangible goods as com¬ 
pared with concerns producing intangible goods. Thus, Costs and 
Profits opens up a new method of approach to the problem of vary¬ 
ing states of business activity, and one which promises to yield 
additional conclusions of significance. 

20. See Chapter XVI, above. 

21. See Chapter XIV, above. 

Chapter XXI 

1. See page 8, above. 

2. See pages 245-246, above. 

3. Irving Fisher, Stabilizing the Dollar , New York, 1920. 

4. Figure 4; page 45. 

5. Pages 162-175. 


400 


MONEY 


6. Page 249. 

7. Chapters XII and XIII. 

8 . Pages 137-139- 

9. See Charles J. Bullock, O. M. W. Sprague, W. B. Donham, “ Fed¬ 
eral Reserve Bank Policy,” in the Harvard Business Review , Jan¬ 
uary, 1923. 

10. Note 4, Chapter II. 

11. Irving Fisher, The Purchasing Power of Money , New York, 1920; 
pages 49-53. 

12. According to a plan proposed by Carl Snyder. Suggested also, in 
connection with an ill-advised proposal for the immediate aboli¬ 
tion of the gold basis of money, by Carl Strover, in Monetary Re¬ 
construction. (Published by the Author, 133 West Washington 
Street, Chicago, 1922.) 

Professor Alfred Marshall says: “It has often been suggested 
that the supply of a nation’s currency itself might ultimately be so 
adjusted as to fix the purchasing power of each unit of the cur¬ 
rency closely to an absolute standard. In spite of the severe criti¬ 
cism to which this suggestion has been subjected, there seems no 
good ground for regarding it as wholly impracticable: but many 
long and tedious studies, stretching perhaps over several genera¬ 
tions; and many tentative experiments moving cautiously toward 
the ideal goal, would need to be taken before any large venture in 
this direction could properly be made.” Alfred Marshall, Money , 
Credit and Commerce , London, 1923; p. 20. 

We believe that now is a propitious time for such experiments, 
even for a large venture. Although we do not yet know enough 
about the relations of money and prices to forecast with precision 
the influence on the price-level of the suggested measure, we do 
know enough to be reasonably sure that the resultant price fluctua¬ 
tions would be small, compared with those which have actually 
occurred under all monetary systems which, like our present sys¬ 
tem, are not definitely devised to curb such fluctuations. And 
every experiment would add to our knowledge. 

13. Chapter XVIII. 

14. Pages 213-219; 228-234. 

15. Note 1, Chapter XIII. 

16. Pages 71-73. 

17. Concerning indexes of employment correlated with indexes of pro¬ 
duction, see William A. Berridge, Cycles of Unemployment , Poliak 
Publication, Number 4, 1923. See, also, Note 1; Chapter XIII. 

18. We agree with Professor Mitchell: “During this year [1921],” he 


NOTES TO CHAPTER XXI 


401 


says, “millions of us were idle when we wished to work, billions of 
dollars’ worth of plant and machinery stood unused when the 
owners longed to start their furnaces, and what we wanted to pro¬ 
duce we needed to consume. The edict of enchantment which for¬ 
bade us to do what we wished was pronounced by the money 
economy. We are periodically mastered by this social machinery 
we have made, and stand idle and needy at its bidding. For with 
all its efficiency the money economy has a fundamental defect — it 
warps the aim of our economic activity. What we want as humcn 
beings is to make serviceable goods. What we are compelled to do 
as citizens of the money economy is to make money. And when for 
any reason it is not profitable to make goods, we are forced to sacri¬ 
fice our will as human beings to our will as money makers. That is 
the heart of the paradox. 

“ If I am right about this fundamental matter, I can hardly be 
wrong in taking an optimistic view of the future. For since the 
money economy is a complex of human institutions, it is subject to 
amendment. What we have to do is to find out just how the rules 
of our own making thwart our wishes and to change them in detail 
or change them drastically as the case may require. Not that this 
task is easy. On the contrary, the work of analysis is difficult in¬ 
tellectually and the work of devising remedies and putting them 
into effect is harder still. But one has slender confidence in the 
vitality of the race and in the power of scientific method if he 
thinks a task of this technical sort is beyond man’s power.” 
(Wesley C. Mitchell, in The Stabilization of Business , New York, 
1923; p. 52-53.) 




INDEX 


Aberthaw Index, cited, 209. 

Aftalion, A., cited, 332. 

American Economic Review, cited, 
10. 

American Federation of Labor, 
cited, 254. 

Anderson, B. M., Jr., cited, 39. 

Annual equation, 321-31; defined, 

322. 

Argentina, fiat money in, 49. 

Aristotle, cited, 9. 

Assignats , 65-66, 93-94. 

Austria, nineteenth-century infla¬ 
tion, 48; depreciation of currency 
in, 49. 

Balanced budgets, necessity of, 135- 
36 - 

Banks, do not hoard money, 86. 

Bank credit, defined, 18; basis of, 
26-28; only in small part deposits 
of currency, 28-30; compared 
with retail food prices (Figure 8), 
182; volume not dependent on the 
value of goods, 216 ff.; unsecured 
by collateral, 233; street loans, 
1919-1921 (Figure 12), 243; undue 
expansion of, 246 ff.; distinguished 
from capital goods, 264; turnover 
of, 302; created by banks and bor¬ 
rowers, 313; effect on circuit time 
of money, 316; in relation to price- 
level, 348, 355; in relation to busi¬ 
ness cycles, 349-50. 

Bank reserves, requirements for, 29- 
3 °- 

Bankers' Magazine (London), cited, 
378 - 79 . 

Barter, clumsiness of, 35-37; de¬ 
fined, 39-40; negligible in extent, 
39-40; develops no market price, 
81; a perfect balance of supply and 
demand, 212 ff.; limited in scope, 
220-21; speculation under, 245; 
overproduction not promoted by, 
271. 


Basic commodities, not stable in 
value, io8-k) 9; (Figure 5), hi. 

Better Banking Bureau, cited, 86, 
114. 

“Big Business,” not autocratic, 192- 
94 - 

Bilgram, Hugo, and L. E. Levy, 
cited, 9, 214. 

Bimetallic controversy, 79. 

Bond Issues, a means of inflation, 
58 - 59 .. 

Bonus bill, 290, 322. 

Book credit, defined, 19; only a 
temporary expedient, 266. 

Boston Five Cent Savings Bank, 85. 

Bouniatian, M., cited, 333. 

Brace, Harrison H., cited, 109. 

Brackett, Basil, cited, 12. 

Buffalo, turnover of bank deposits 
in, 302. 

“Business as usual,” impossible in 
time of war, 195. 

Business cycles, a composite of many 
cycles, 298; causes of, 332-36; 
caused by “over-saving,” 340- 
42; analyzed, 349. 

Business stability, necessary for 
maximum productivity, 285; de¬ 
pendent on rate of flow of money, 
309; not dependent on balanced 
industry, 327. 

Buyers, determine production sched¬ 
ules, 190 ff.; strategic position of, 
227. 

“Buyers’ Strike,” 292 ff. 

Buying a mass movement, 245-46. 

Cameron, Lieutenant Verney L., 
cited, 35. 

Capital goods, as essential agents 
of production, 251; distinguished 
from consumers’ goods, 251; fixed 
capital distinguished from free 
capital, 251; result of saving, 253; 
supply dependent on profits, 256; 
growth curbed by taxation, 260; 



404 


INDEX 


excesses of, 263; rapid growth fol¬ 
lowing World War, 272; excessive 
development of, 340. 

Capitalism, and standards of living, 

251 ff. 

Capper, Senator, cited, 131. 

Carlile, William W., cited, 44. 

Carlton, F. T., cited, 9. 

Carver, T. N., cited, 8; 386. 

Cassel, Gustav, cited, 75, 140, 161, 
205. 

Circuit flow of money, to consum¬ 
ers, 289 ff.; and the Douglas the¬ 
ory, 338; and the Hobson theory, 

341 - 43 - . . 

Circuit velocity of money, in savings 
banks, 294; defined, 300; factors 
that alter, 314 ff. 

Civil War, inflation of currency dur¬ 
ing, 231. 

Clay, Henry, cited, 9, 32. 

Coal production, 1880-1920 (Figure 
6 ), 1 13 - 

Coin’s Financial School, cited, 81. 

Commercial and Financial Chronicle , 
cited, 51. 

Commodities, variations since 1913 
in quantities marketed (Figure 
10), 207; producers’ and consum¬ 
ers’, 286; flow of, 299. 

Commodity basis of money, 97 ff. 

Commodity markets, the center of 
interest, 283-84. 

Competitive business is democratic, 
192-94. 

Consumers control production sched¬ 
ules, 190-92. 

Consumers’ fund, not fixed, 291. 

Consumers’ goods, distinguished 
from capital goods, 251, 286. 

Consumers’ incomes, more impor¬ 
tant than confidence, 281-83; how 
increased, 289; depend in part on 
circuit time of money, 298 ff.; 
sources of, 304; index needed, 395. 

Consumption, velocity of money 
used in, 174; harmful when exces¬ 
sive, 258; gap between consump¬ 
tion and production, 270; per cap¬ 
ita, 291; production-consumption 
equation, 321 ff. 

Continental paper money, 48. 

Cost of living, fluctuations in (Fig¬ 
ure 3), 44; compared with cost of 
basic commodities (Figure 5), 111; 


not a sound basis for fixing wages, 
254; in relation to profits, 334- 
3 6 - 

Costs in relation to the annual equa¬ 
tion, 332. 

Cows as currency, 77. 

Credit. See Bank credit. 

Crises, causes of, 332-34. 

Crop production (Figure 6); 113. 

Crothers, Samuel McChord, cited, 
201. 

Currency, defined, 22-24. 

Currency in circulation, trend of, 
compared with population (Figure 
2), 23. 

Cutting, H. C., cited, 102, 114. 

Davenport, H. J., cited, 9, 38, 76. 

Day, Edmund E., cited, 229. 

Dearborn Independent , cited, 80-81, 
82, 84, 86, 109, 128, 129, 131, 132, 
135 , 140. 

Deflation, defined, 55; evil effects of, 
74-75; banks do not profit by, 86. 

Demand, defined, 30-31; in advance 
of goods due to time factor, 269 ff. 

Demand and supply. See Supply 
and demand. 

Deposits. See Bank credit. 

Depreciation. See Inflation. 

Depression of 1920, 263, 279, 293, 
296, 319. 

Douglas, C. H., cited, 190, 198, 333, 
334-35, 336, 3371 his theory ex¬ 
plained, 336-37. 

Economic function of price, 186 ff. 

Economic problems, chiefly mone¬ 
tary, 351-53- 

Economics, defined, 16-17. 

Edison, Thomas A., cited, 47, 83, 94, 
133; commodity money plan, 97 ff. 

Effective demand, defined, 30. 

Elastic monetary system, defects of, 
246 ff. 

England, depreciation of currency 
in, 49; unrest in, due to inflation, 
68-70; ratio of gold to note issues, 
85; price fluctuations in, no. 

“Enough money to do business 
with,” 264, 363 ff. 

Equation of exchange, 157 ff.; inade¬ 
quacy of, 301. 

Equitist League, cited, 91. 

Essential industries, 126-27. 




INDEX 


405 


Exchange of goods, always deferred 
by money, 222-24. 

Exchange rates, before the World 
War, 139; not fixed by fiat of 
bankers or governments, 140-41. 

Extravagance, promoted by infla¬ 
tion, 71-73; promoted by excess 
profits taxes, 73. 

Fallacies, concerning supply and de¬ 
mand, 109; favorable balance of 
trade, 147-51; surplus production, 
I 5 I- 53; relation of money and 
goods, 239 ff., economizing credit, 
310. 

Farm Products, fluctuations in 
value, 109-12. 

Farmers’ problems, 98. 

Favorable balance of trade fallacy, 
I47-50- 

Federal Reserve Bank notes, as 
paper money, 23; how and by 
whom issued, 24. 

Federal Reserve Bank of New York, 
cited, 312. 

Federal Reserve Board, membership 
of, 25; chairman, cited, 217; policy 
of, 356-58. 

Federal Reserve notes, as paper 
money, 23; volume of, 24; security 
behind, 26; in Edison money plan, 
98 ff., not commodity money, 
105-06. 

Federal Reserve System, organiza¬ 
tion of, 25; relation of, to bank 
credit, 29; expansion of bank 
credit under, 229; facilitates spec¬ 
ulation, 249; as a stabilizer of 
price-levels, 356. 

Fetter, F. A., cited, 9, 10. 

Fiat money. See Paper money. 

Filene’s automatic bargain base¬ 
ment, 199. 

Fisher, Irving, cited, 154, 155, 156, 
159 , 163, 311, 317, 354 - 

Fisher, Lettice, cited, 214. 

Flow of money. See Circuit flow. 

Fluctuations, in business (Figure 1), 
2, 365; in value of gold, 43-48; in 
cost of living, 44; in price, central 
factor in business cycles, 349-50; 
in prices, means of mitigating, 
354-63; in prices and interest 
rates, 358. 

Ford Company, cited, 182. 


Ford, Henry, cited, 88-89. 

Foreign debts, payment in gold an 
asset or a liability? 279. 

Foreign exchange, fluctuations in, 
141 - 43 . 

Foreign trade, use of gold in, 137-39; 
requires a common measure of 
value, 141-42; requires stable 
money in home markets, 144-47; 
does not require a favorable bal¬ 
ance of trade, 147-51; unbalanced 

^ by inflation of bank credit, 235-37. 

France, depreciation of currency in, 

^ 49; ratio of gold t6 note issues, 85. 

Fraser, Sir Drummond, cited, 59. 

Function of price, 186 ff. 

Gantt, H. L., cited, 198. 

Germany, depreciation of currency 
in > 49, 57, 88, 123; exports to, 51; 
ratio of gold to note issues, 85; sale 
of marks abroad, 143. 

Gide, Charles, cited, 239, 240. 

Gold, not a standard, 43-48; unsta¬ 
ble in exchange value (Figure 3), 
44; 46-48; stocks, in relation to 
prices (Figure 4), 45; value af¬ 
fected by supply and demand, 46, 
109; as a basis of money, 77 ff.; as 
a stabilizer of money values, 80- 
81; in international trade, 137 ff.; 
export and import points, 139; 
imports may increase production, 
149, 169. 

Gold production, affects only long- 
trend prices, 45-46. 

Gold reserves, used to maintain con¬ 
vertibility, 82-83; must be used 
freely, 85-87; small cost of, 124; 
may be used to stabilize prices, 
360; may be needed for export, 
362. 

Goods, defined, 30; workers not paid 
in, 275. 

Goods option that goes with money, 
224-25. 

Goods transferred without money, 
163-67. 

Gough, George W., cited, 188, 214, 

2 55 - f . , 

Government control of industry, 

100; 343-45- 

Government financing, a cause of 
inflation, 234. 

Government inefficiency, 261. 




INDEX 


406 

Great Britain, inflation in, 73. 

Guaranty Trust Company Bank 
Catechism, cited, 148. 

Hare, Sir Lancelot, cited, 64, 214. 

Hastings, H. B., cited, 62; 349. 

Hawtrey, R. G., cited, 12. 

Herr, E. M., cited, 296. 

High cost of living, due to inflation, 
67-69; not a bar to foreign trade, 
146; causes of, 210. 

Hobson, J. A., cited, 254, 334, 340, 

345 * 

Imports, a cause of business depres¬ 
sion, 279. 

Inconvertible paper money. See 
Paper money. 

Index Numbers, Irving Fisher’s 
methods, 155-56; Aberthaw Index 
of building costs, 209. 

Indirect taxation, by means of infla¬ 
tion, 61-62; Liberty Bonds a 
means of, 64. 

Inflation, defined, 54-56; vicious 
spiral of, 56-67; through bond is¬ 
sues, 57; as indirect taxation, 61- 
62; in Japan, 66; in Central Eu¬ 
rope, 66-67; promotes inefficiency, 
72; arbitrary restraint needed 
upon, 87-90; under Edison money 
plan, 118-121; does not lower in¬ 
terest rates, 131-33; results in 
Europe, 1922 (Figure 7), 145; in 
United States by means of bank 
credit, 231 ff.; a drug habit, 279; 
curbed by interest rates, 359. 

Instability of money. See Inflation. 

Intangible goods, defined, 30. 

Interest charges, are they unjust? 
128-36; increased by inflation, 
131-33; should governments pay 
interest? 133-36. 

Interest rates, how determined, 129- 
31; a necessary means of distribut¬ 
ing savings, 136; right level of, 
267; and prices, 358. 

International currency, not needed, 
138. 

International trade. See Foreign 
trade. 

Italy, depreciation of currency in, 49. 

Japan, inflation in, 49; deflation in, 
74; money issued on land, 94. 


Jernigan, T. R., cited, 66, 74. 

Jevons, J. Stanley, cited, 8, 14, 43, 
78, 220. 

Johnson, Joseph F., cited, 8, 15, 

73 * 

“Joy riders,” 323. 

Keynes, J. M., cited, 168. 

King, W. I., cited, 229. 

Knight, Frank H., cited, 163. 

Labor , cited, 181. 

Labor-hours, as units of exchange, 
91-92. 

Ladd, Senator, cited, 95, 205. 

Lamont, Thomas W., cited, 279. 

Land, as a basis of money, 93-95. 

Laughlin, J. Laurence, cited, 9, 154, 
216. 

Lavington, F., cited, 281. 

Layton, W. T., cited, 57. 

Lescure, Jean, cited, 333. 

Levasseur, E., cited, 9. 

Liberty Bonds, coupons used as 
money, 18; a means of indirect 
taxation, 64. 

Literary Digest, cited, 193. 

Loans. See Bank credit; vs. taxes, 

57 - 6 i* 

Locke, John, cited, 363. 

Losses due to depressions, 2. 

Loucks, H. L., cited, 86, 93. 

Macaulay, T. B., cited, 4. 

Making of Index Numbers , cited, 
155, 206. 

Manchester Guardian, cited, 168. 

Marshall, Alfred, cited, 11, 42, 384, 
400. 

Massachusetts land-currency, 94. 

May, R. E., cited, 332. 

Measurement of the price-level, 155- 

5 6 ; 

Medium of exchange, necessity of, 
32 fL 

Melrose, C. J., cited, 102. 

Mill, John Stuart, cited, 7, 8, 12, 37, 
64. 

Mitchell, Wesley C., cited, 10, 11, 
116. 

Money, a central human interest, 4- 
6; neglected in economic theory, 
7-10; defined, 17-18; as a medium 
of exchange, 32 ff., as a standard of 
value, 41 ff., 362; instability of, 



INDEX 


407 


41 ff.; essentials of, 78-80; commod¬ 
ity basis of, 97 ff.; velocity of, 158, 
173—75; quantity theory, 160 ff.; 
as suspended purchasing power, 
212 ff.; makes possible unbalanc¬ 
ing of supply and demand, 213 ff.; 
always defers exchange of goods, 
222; in relation to goods, 228 ff.; 
unlike other forms of capital, 262; 
advanced in production, 269 ff., 
339; in consumption, 277 ff.; the 
force that moves industry, 277 ff.; 
circuit flow of, 298 ff.; created 
and extinguished in banks, 313; 
enough to do business with, 326, 
363-66. 

Money in circulation, defined, 19; 
kinds of, 22-24; in U.S.A., 1923, 
374 - 

Money transferred without goods, 
163-67. 

Money vs. wealth, 20-21, 119. 

Monopoly prices, 187. 

Muscle Shoals project, 88. 

National Bank notes, as paper 
money, 23; how issued, 24. 

National Banks, increase in deposits, 
I9I5~ I 920, 229. 

National Bureau of Economic Re¬ 
search, cited, 304, 311. 

National Monetary Conference at 
Brussels, cited, 136, 378. 

Newcomb, Simon, cited, 160, 166, 
299. 

New Republic, cited, 388. 

New York Times, cited, 181. 

Nicholson, J. Shield, cited, 16, 151. 

“Normal,” confusion due to use of 
the word, 53, 167; misuse of the 
term, 329. 

Northcott, C. H., cited, 73, 293. 

Ohlin, Bertil, cited, 53. 

Options that go with money, 199, 

29 1 ff. 

Overproduction, associated with the 
time factor, 269 ff., 324-26. 

Palladium, cited, 86. 

Panama Canal, paid for out of sav¬ 
ings, 273. 

Paper money, kinds of in the United 
States, 23-24; depreciation of, 
48-50; instability of, 48-50, 102; 


arbitrary restraint needed, 87-90; 
in foreign exchange, 142; deprecia¬ 
tion of in Europe, 1922 (Figure 7), 
145 . 

Patterson, R. H., cited, 34. 

Penson, Sir Henry, cited, 67. 

Physical volume of production, esti¬ 
mates of, 229. 

Physical volume of trade, 169. 

Place option that goes with money, 
225-27. 

Poliak Publications, Number 3, 
cited, 62; 349. 

Population, trend of, compared with 
currency (Figure 2), 23; compared 
with production (Figure 6), 113. 

Price control, by government ineffec¬ 
tive, 201. 

“Price economists,” 10. 

Price fixing, 189; impossibility of, 
208. 

Price-level, defined, 22, 154-55; in 
relation to stocks of gold, 45-46; a 
composite of many price-levels, 
172; what should it be? 356. 

Prices, in relation to stocks of gold 
(Figure 4), 45; compared with 
bank loans, 1913-1921 (Figure 8), 
182; controlled by buyers, 197 ff.; 
a measure not a cause of trouble, 
204; variations since 1913 (Figure 
9), 206; in relation to business 
cycles, 349-50. 

Producers’ commodities, defined, 
286. 

Production, schedules controlled by 
consumers, 190-92; requires capi¬ 
tal goods, 251; determines stand¬ 
ards of living, 253, 284; requires 
money, 265; time factor in, 269 ff.; 
always planned to meet future 
demand, 278; sustained only by 
money spent in consumption, 280; 
based on estimates of future mar¬ 
kets, 281 ff.; at maximum requires 
business stability, 309-10; volume 
of in the United States, 364. 

Profiteers, 204-05, 209, 243. 

Profits, effect of undivided profits on 
circuit time of money, 317; in re¬ 
lation to the annual equation, 332; 
in relation to the cost of living, 
334-36; flow of, to consumers, 
341-43; and business, depressions, 
346-48. 



INDEX 


408 

Property, security of, necessary, 
255 - 5 . 6 . 

Proportional Representation League, 
cited, 192-93. 

Prosperity, illusion of, due to infla¬ 
tion, 73. 

Psychological aspects, of price fluc¬ 
tuations, 170-71, 245-46; of busi¬ 
ness revivals, 280 ff.; of consum¬ 
ers’ demand, 292 ff.; of fluctua¬ 
tions in circuit time of money, 316. 

Purchasing power parity, 146; res¬ 
toration of former parities impos¬ 
sible, 146-47. 

Quantity theory of money, 160 ff.; 
practical value of, 175-84, 357. 

Railroad difficulties, due mainly to 
inflation, 235. 

Real wages, vs. money wages, 69-70; 
dependent on savings and invest¬ 
ments, 256 ff. 

Rediscount rates, and price-levels, 

357 - 6 i. 

Reeve, Sidney A., cited, 387. 

Reparations, dilemma of, 237. 

Reserve ratio, in Europe during 
World War, 85; no longer a safe 
guide, 359. 

Retail food prices, compared with 
bank loans (Figure 8), 182. 

Retail sales, compared with whole¬ 
sale, 295; compared with money 
in circulation, 296. 

Right prices, 188-90. 

Rorty, M. C., cited, 285, 303. 

Russia, irredeemable paper money 
in, 49; inflation in, 88, 119, 120. 

St. Clair, Oswald, cited, 164, 165, 
216. 

Sauerbeck, Augustus, cited, 44, 47, 

no. 

Savings, capital goods due to, 253, 
encouraged by safety, 255; largely 
involuntary, 259; effect on circuit 
time of money, 316, 352. 

Savings banks should require notice 
of withdrawals, 86. 

Seager, H. R., cited, 32. 

Sears, Roebuck Company, sales in 
1920-1921, 296. 

Self-liquidating paper may cause in¬ 
flation, 217-18. 


Seligman, E. R. A., cited, 32. 

Services, defined, 30; less important 
than commodities, 283-84. 

Silver, dollars, 23; value maintained 
by limitation of quantity, 89; re¬ 
serves in United States Treasury 
of no monetary use, 90. 

Sisson, Francis H., cited, 390. 

Smith, Adam, cited, 307, 365. 

Snyder, Carl, cited, 72-73, 229. 

Social unrest, caused by inflation, 
67-71. 

Soldiers’ Bonus Bill, 290, 322. 

Sound money, not necessarily stable, 

357 . 

Spain, nineteenth century inflation, 
48. 

Spalding, William F., cited, 240. 

Speculation, promoted by inflation, 
65; not curbed by Edison plan, 
118; increased by inflation, 170; 
in commodities, 242 ff.; facilitated 
by bank credit, 242 ff.; in sugar, 
244; in New York (Figure 14), 
302; effect on circuit time of 
money, 317. 

Spiethoff, A., cited, 333. 

Spiral of inflation, 56-57, 67, 74, 94, 

349 - 

Sprague, O. M. W., cited, 229. 

Stable dollar, 354. 

Standard of value, money as a, 41 ff. 

Standards of living, as bases for 
wage rates, 68, 254; and capital¬ 
ism, 251 ff.; dependence on pro¬ 
duction, 253, 284. 

Stewart, Walter W., cited, 229. 

Sunshine cure for business depres¬ 
sion, 280 ff. 

Supply, defined, 30-31. 

Supply and demand, defined, 30-31; 
as viewed by business men, 177; 
perfectly balanced in barter trad¬ 
ing, 212 ff.; upset by increase of 
money, 228 ff.; upset by govern¬ 
ment financing, 234-35; not the 
same thing, 324-26; in relation to 
the annual equation, 330. 

Surplus production fallacy, 151-53. 

Suspended purchasing power, 212 ff. 

Szebenyei, Joseph, cited, 41, 66-67. 

Tangible goods, defined, 30. 

Taxes, less costly than bond issues, 
57-61; vs. loans, 57-61; may curb 




INDEX 


409 


growth of capital goods, 260-62; 
from tobacco, 296; decreased 
taxes decrease circuit time of 
money, 316. 

Thrift, meaning of, 352. 

Time-factor in production, 269 ff. 

Time option that goes with money, 
219-24. 

Turner, J. R., cited, 9. 

“Unbalanced state of industry,” 
327 . 

United States Steel Corporation, 
control of prices, 200. 

United States Treasury Notes, 23- 

: 24. 

Unstable money, morally disastrous, 
63-67; socially disastrous, 67-71; 
economically disastrous, 71-73. 

Van Deventer, John H., cited, 292. 

Veblen, Thorstein, cited, 323. 

Velocity of money, 158, 173-75, 3°°* 

Vertical integration of industry, de¬ 
creases circuit time of money, 317. 

Volume of production, determined 
by buyers, 196 ff.; compared with 
prices (Figure 11), 230. 


Volume of trade, compared with 
volume of farm products, 112-14; 
compared with prices and produc¬ 
tion (Figure 11), 230. 

Wage-lag, 68-69; 339- 

Wages, those that facilitate con¬ 
sumption, 288; increased wages 
decrease circuit time of money, 
315- 

Wages of railroad workers, 70-71. 

Wallis, Percy and Albert, cited, 216. 

War Finance Corporation, 237. 

Watts, F. O., cited, 214. 

Webster, Pelatiah, cited, 64. 

Wells, H. G., cited, 4. 

Wheat, fluctuations in price, no. 

White, Andrew D., cited, 65. 

White, Horace, cited, 9. 

Wholesale prices, 1914-1921 (Figure 
4), 45- 

Wholesale sales, compared with re¬ 
tail, 295. 

Workers, not paid in goods, 275. 

Yardstick, a standard as money is 
not, 41-42. 



















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